MCF - Master in Corporate Finance - SDA Bocconi

MASTER IN CORPORATE FINANCE

MULTIPLES: THEORY AND PRACTICE

Alberto Dell’Acqua, Ph.D.

1 Intro & valuation road map

2 Identifying/selecting comparables

3 Types of multiples

4 Multiples in practice: input the correct data

5 Interpreting results

6 Conclusions

SUMMARY

Comparable

Companies’

Multiples

Market

Information

Current Market Valuation Company Valuation

DCF

Analysis

In-Depth Analysis

Comparable

Transactions’

Multiples

Comparable Companies’ Trading Multiples and Comparable Transactions’ Multiples

represent the “market perspective” and the most commonly used valuation instrument

1. INTRO TO “COMPS” VALUATION

Overview of Valuation Process

Source: Merrill Lynch (M&A)

COMPARABLE

COMPANIES’

TRADING

MULTIPLES

Comparable Companies vs. Comparable Transactions

AGGREGATE VALUE REFERENCE DATE

COMPARABLE

TRANSACTIONS’

MULTIPLES

Market value of a standalone

company

Consideration paid by an acquiror

for a company acquisition

Value includes takeover premium

(“premium for control”)

Value of a company’s shares

today

Multiples are expressed relative

to current or expected

performance

Value paid in transactions

occurred in the past

Multiples are expressed relative

to historical financials of target

company

1. INTRO TO “COMPS” VALUATION

EQUITY MULTIPLES ENTERPRISE

MULTIPLES

WHO

USES

IT

WHAT IT GIVES

YOU

Financial

Analyst

Key

Pros

DCF LEVERAGED VALUE

Retail

Investors

Financial

Analyst

Private

Equity

Common Equity

Value only

Firm value which

can be converted

to equity value

Fundamental value

of a company

including value of

control

How much debt

a company can

bear

Easy to calculate

and to understand

Avoids worst

accounting

distorsions

Not distorted by

market events

or accounting

policies

To estimate how

much a financial

buyer can pay

1.VALUATION ROAD MAP

EXCESS CASH

OPERATIONAL

ASSETS

OPERATIONAL

LIABILITIES

Blue = Assets and liabilities determined by a company’s financial strategy

DEBT

EQUITY

Grey = Assets and liabilities driven by everyday strategic operational and

investing decisions

The Balance Sheet will help you understand the relationship

between Equity Value and Enterprise Value or Firm Value

Fixed Claims

Residual Claims

Excess cash means….

remaining cash

after operational

needs are met

1. THE FOUNDATION

Alpha’s Enterprise Value: an example

- The market capitalisation of Alpha is 1.500.000

- The total value of short and long term debt on Alpha’s balance sheet

is 7.500

- The value of cash on Alpha’s balance sheet is 106.000

- The value of short-term investments on Alpha’s balance sheet is 50.000.

We treat short-term investments as cash equivalents.

Calculating Enterprise Value:

Equity value 1.500.000

+ Debt 7.500

- Cash 106.000

- Short-term investment 50.000

= Enterprise Value 1.351.500

1. THE FOUNDATION

Enterprise value to equity value – and back

- Enterprise Value represents the market value of the company’s net

operational assets plus the value of its future growth opportunities and

intangible assets not on the balance sheet.

- Equity value represents the market value of the shareholders’ investment

in the business.

- The following equations provide simple conversions between Equity and

Enterprise Value:

Market Capitalisation = Share price * shares outstanding

Enterprise Value = Market capitalisation + net debt

Enterprise Value = Market capitalisation + debt - cash

Equity Value = Enterprise value + cash - debt

1. THE FOUNDATION

Principle: multiples valuation starts with identifying appropriate comparable

companies.

Take the perspective of an investor in equities (shares) when you are identifying comparables. Equity

investors focus on companies’ future profitability, so choose companies with comparable drivers of

future profitability.

Steps: STEP ISSUE

1. Identifying/selecting comparables

Verifying the meaning and the coherence of the multiples

“Cleaning” the sample

2. Choosing the proper grid of multiples for the evaluation

Searching for relevant relationships among multiples, business models and value drivers

Use the same approach in comparing multiples of different companies (restatement methods, accounting standards)

3. Analysis of results Choosing the proper grid of multiples for the evaluation

2. BASIC COMPARABLES

Select the right comparable companies’ universe

Input the correct data

Interpret results

Apply results

Doing the “Comps” through four stages:

Doing the comps in practice

2. BASIC COMPARABLES

Principle: in general, in order to identify the appropriate combination of

companies you should analyse the following factors:

KEY DRIVERS

• Business

• Business mix (conglom. vs pure player)

• Perspective of growth

• Size of business

• Business profitability

• Geographic presence

• Stock liquidity

• Level of investment

• Financial strength

• …

PARAMETERS • Activity

• Revenues split, EBITDA

• Growth rate of sales and profits, market

share, quality, economics

• Sales

• Margins (EBITDA/EBIT margin, ecc..)

• Geographic sales mix

• Free float

• Capital expenditures (capex)

• Debt ratios (D/E, Net Debt/EBITDA,…)

• … Where you can get these numbers:

Analyst researh, research company database (Bloomberg, Facset,..), annual reports,

specialized industry publications, broker reports.

2. COMPARABLES CHECKLIST

You can choose either an enterprise or an equity value multiple. Enterprise

multiples use earnings above the interest line; equity multiples use earnings

below the interest line.

3. TYPES OF MULTIPLES

ENTERPRISE

VALUE

DEBT • Ent Value/Sales

• Ent. Value /EBITDA

• Ent. Value / EBIT

• Ent. Value /CF • P/E

• P/Cash

Earnings

• P/BV

EQUITY

VALUE

10

1tt

e

t

)k(

DIVP

ek

EP 0

0

ekE

P 1

0

0


PE with no growth: determinants and equations

gk

gDIVP

e

100

1

00

1

1

tt

t

)k(

gDIVP

e

gk

gpayout

E

P

e

1

0

0

gk

payout

E

P

e

1

0

DIV0 =E0payout

E0 (1+g) = E1

g = (1-payout)ROE

PE with growth: determinants and equations


WACC

t

EBIT

EV c

1

0

0

WACC

tEBITEV c )1(0

0

EV/EBIT with no growth: determinants and equations


WACC

tEBITEV c )1(0

0

WACC

tROSSalesEV c )1(

0

Sales × ROS

WACC

tROS

Sales

EV c )1(00

EV/Sales with no growth: determinants and equations


PROS MULTIPLES CONS

EV/CF

• It is not affected by accounting policies

• It takes into account only monetary costs

• FCF are more complex to

calculate • The volatility of cash flows could

affect the effectivness of the valuation.

EV/Sales

• It is used when sales are the

main key driver

• Negative margins, cash flow

• It implies the same level of

profitability

• It could be considered as a proxy of the operating cash flow (before capex)


• It doesn’t take into account the invested capital (depreciation)

EV/EBITDA

• It takes into account the invested capital

• It is a measure of the operating profitability of the firm

• It is affected by accounting

policicies (ie depreciation) EV/EBIT

Enterprise Value


P/E

P/Cash

Earnings

(1)

P/BV

• Semplicity

• Differences in accounting policicies

• Differences in tax management • Differences in financial

structure choice


• Not popular • Differences in taxation • Differences in accounting

principles (except depreciation policy) and in financial structure choices

• Importance of tangible assets in the valuation

• Differences in accounting principles could lead to a misleading interpretation in comparing companies.

(1) Net profit + Depreciation + Amoritsation

Equity Value

PROS MULTIPLES CONS


PRICE

– Source data (Facset, Bloomberg, Datastream)

– Market stock price

– Period of flows to use to estimate multiples :

o Current multiples:

– are obtained by comparing stock

prices and the last available balance

sheet

o Trailing multiples:


prices and the results of the last

twelve months before the date chosen

to calculate the index. Results on the

previous twelve months are taken by

the four quarterly report or the last by-

yearly report, provided by the

companies

o Leading multiples:


prices and the expected results of the

following year or those of the next

ones. Estimations are usually taken by

the consensus forecast, published by

financial analysts associations. In

Europe the most reliable are IBES and

DataStream

T0

0

E

P

L12M

0

E

P

T1

0

E

P

Current

multiple

Trailing

multiple

Leading

multiple

Where:

EL12M = earnings per share referring to the last 12

months

ET1 = earnings per share expected for the next year

E T0 =earnings per share generated in the last year.

Current, Trailing and Leading Multiples


BALANCE SHEET VALUES

Equity Market Value

Debt

Financial Debt

ST/LT Borrowings

Bond/Convertible bond

Others (Preferred shares, Operative leasing, Pension funds, ..)

Book value (last balance sheet/available interim)

Book value (last balance sheet/available interim)

Market value if available

Book value/Market value if available

Liquid assets

Cash

Stocks

Sum of money as security

Book value

Market value if available

Book value

Minorities Market value or Book value (last balance sheet/available interim)

Equity investments Market value or Book value (last balance sheet/available interim)

4. MULTIPLES IN PRACTICE the numerator

Shares

1. First Method: number of outstanding shares (without considering treasury stock)

2. Second Method: number of outstanding shares (including treasury stock). The

market value of treasury shares is added to the liquid assets of the company.

The first method is the most used.

EQUITY VALUE = Price x N. shares

Data Method 1 Method 2

Price (euro) 10 10 10

n. share issued (mln) 10 10 10

n. treasury shares (mln) 2 2 0

n. shares (mln of euro) 8 10

Equity value (mln of euro) 80 100

Debt (mln of euro) 50 50 50

Cash (mln of euro) -10 -10 -30

Net Debt (mln of euro) 40 20

Enterprise value (mln of euro) 120 120

4. MULTIPLES IN PRACTICE dealing with treasury stocks

The Market value of debt: - Typically, book value of debt is a good proxy for market value

For highly distressed companies and hybrid debt, use market value

- Figure for cash balances and short-term liquid investments excludes cash balances

needed to run the business

- Use most recent balance sheet, adjust for any material changes (acquisitions, disposals,

capital increase)

- Always check whether anything material happened since the last balance sheet

- Always check the consistency between your balance sheet data and your operating

data

Example:

Latest balance sheet is published in March 05, for FY ending Dec 04

In April 05, the company issue a US$100m bond

You do the comps today and your forecasts include the interests paid on this bond (say

US$5m a year) and future yield on new investments

4. MULTIPLES IN PRACTICE dealing with financial debt

COMPARABLES- MINORITIES

MARKET VALUE BOOK VALUE

Change = - 1,1x

EXAMPLE: TELECOM ITALIA 16/11/2004

Market cap (in €mm) 42.766,7

Net debt/(cash) 31.421,0

Minorities 4.249,0

Altro (2.198,0)

Firm value (in €mm) 76.238,7

2004A 2005E 2006E

EBITDA (€ mm) 14.532,0 15.131,3 15.589,3

EV/EBITDA 5,2x 5,0x 4,9x

Market cap (in €mm) 42.766,7

Net debt/(cash) 31.421,0

Minorities 20.116,6

Others (2.198,0)

Firm value (in €mm) 92.106,3

2004A 2005E 2006E

EBITDA (€ mm) 14.532,0 15.131,3 15.589,3

EV/EBITDA 6,3x 6,1x 5,9x

MINORITIES

Participation To do: adjust: Equity Income

Listed Participation % hold % no hold Market Cap Value in TIM 56% 44% 43.604 19.128 TI Media 62% 38% 1.056 396 Ente Chile 55% 45% 1.310 593 xxx

Sub-total 20.117 Discount 0% Sub-total (a) 20.117

4. MULTIPLES IN PRACTICE dealing with minorities

Minority interests should be added to net debt and calculated at market value

COMPARABLES METHOD

EQUITY VALUE

NET FINANCIAL

POSITION

MINORITIES

ADJ. NFP

EXAMPLE: TELECOM ITALIA 16/11/2004

Market data Share B Share A

Stock price (Last) as of : I:TIT 2,18 2,95 12 months high 2,18 2,98 12 months low 1,62 2,34

Number of shares Issued (mm) 5.795,9 10.315,3 Treasury Shares (101,2) Shares issue from Options (Treasury Method) na

Fully diluted number of shares (mm) 5.795,9 10.214,1 Market cap (in €mm) 42.766,7 Net debt + minorities + other 49.339,6 Firm value (in €mm) 92.106,3 Capitalised Leases na Adjusted Firm value (in €mm) 92.106

Balance sheet elements as at 31/09/2004 Financial debt (incl. Financial Lease) 31.421,0 Cash Net debt/(cash) 31.421,0

Minorities 20.116,6 Net debt/(cash) + Minorities 51.537,6

Underfunded Pension Plan na Equity Method - Participations (2.198,0) Preferred na Net Debt + Minorities+ Other 49.339,6

Capitalised Leases na Shareholders equity group share 14.730,0 Net debt / Market Value 73,5%

4. MULTIPLES IN PRACTICE

an example

– The economic-financial variables of the companies in the sample must be

consistent with the economic-financial data of the company that you intend to

evaluate.

– Reconciliation of the historical/forecasted data:

• Restatement of the

Income Statement

with an adequate

level of detail…

• Time horizon

coherence

• Normalization

• Consistency between

numerator and denominator

• Different accounting standards

• Homogeneous time horizon

• Adjust. for exceptional events

(extraordinary items,

restructuring costs, goodwill,

accounting changes…)


consistency of the valuation

As Reported

EBIT 100

Restructuring Charge

(50)

Pre tax Profit 50

Tax (33%) (17)

Net Income 33

Restated

EBIT 100

Pre tax Profit 100

Tax (33%) (33)

Net Income 67


exceptional non-recurring items - example

All exceptional items should be restated in order to normalize the result the

valuation will be based on.

General rule:

Use max, min, median and mean

formulas - exclude outliers

Projections based on research reports from investment banks

Share prices as of November 25, 2005

All multiples are calendarised to 31st Dec

Market Enterprise Enterprise Value as a Multiple of: EPS Dividend

Company Value Value Sales EBITDA Cash P/E 5-YR PEG Yield

Name (EURm) (EURm) LTM 2005E 2006E LTM 2005E 2006E 2005E 2006E CAGR 2005E 2006E LFY

Luxury/Fashion

Geox 2,374 2,357 5.27x 5.18x 4.09x 19.2x 19.2x 14.0x 32.8x 25.4x 18.0% 1.82x 1.41x 0.7%

Bulgari 2,599 2,725 3.10 2.98 2.71 15.2 14.4 13.0 21.8 19.0 13.6 1.61 1.40 1.4

Richemont 18,858 18,480 2.80 2.73 2.48 14.8 14.7 12.6 23.2 18.9 9.5 2.44 1.98 1.9

LVMH 34,686 41,536 3.15 3.04 2.84 13.5 13.4 12.0 24.1 20.8 9.7 2.48 2.14 1.3

Tod's 1,614 1,562 3.19 3.14 2.76 14.5 13.9 11.7 29.5 23.8 12.7 2.33 1.88 0.8

Hermès 7,255 6,745 4.96 4.65 4.19 16.4 15.0 13.5 28.5 25.1 12.0 2.37 2.09 0.0

Tiffany & Co 5,441 5,676 2.89 2.76 2.53 13.7 13.5 12.0 26.2 23.6 13.0 2.02 1.82 0.0

Swatch Group 7,262 6,504 2.46 2.36 2.18 11.4 10.5 9.6 28.3 26.2 11.1 2.55 2.36 0.9

Burberry 3,026 2,778 2.63 2.60 2.47 9.9 10.3 9.5 19.5 16.8 11.0 1.78 1.53 1.6

Max 5.27x 5.18x 4.19x 19.2x 19.2x 14.0x 32.8x 26.2x 18.0% 2.55x 2.36x 1.9%

Mean 3.38 3.27 2.92 14.3 13.9 12.0 26.0 22.2 12.3 2.15 1.85x 0.9

Median 3.10 2.98 2.71 14.5 13.9 12.0 26.2 23.6 12.0 2.33 1.88 0.9

Min 2.46 2.36 2.18 9.9 10.3 9.5 19.5 16.8 9.5 1.61 1.40 0.0

5. INTERPRETING RESULTS

key statistics

Source: Merrill Lynch

- Analyse company’s P/E in relation to earnings growth prospect

PE/G P/E

LT Growth Rate =

- The higher the PEG is, the more you pay for growth

Company A: P/E = 25 growth 17% PEG: 1.47

Company B: P/E = 16 growth 10% PEG: 1.60


adjusting for growth

The PEG tells you if your company is overvalued or (in other terms) if the market is

extremely confident in the expected growth rates implied in the current valuation.

The evidence reported in the Value Map analysis suggests undervaluation for

Swatch, Richemont and LVMH.

Source: FactSet and Reuters. Prices as of 21 September 2004


comparison with peers in the luxury industry

VALUE MAP

The same analysis

can be developed

on the other

variables:

-EV/Sales vs

EBITDA margin

- EV/EBITDA vs

CAGR

- …

1. Negative Earnings

- Loss-making

- Risk of bankruptcy

2. Absence of Historical Information

- Recent business transformation

- Recent IPO and privatization

3. Absence of comparable companies

Use DCF

Use DCF

Use DCF

Useful Hints


Potential pitfalls of multiples valuation

Rationale

- Determine value of transaction

- Determine multiples compared to target’s financial performance and pre-

announcement market value

- Determine control premium of specific industries

Comparability

- Companies involved in transactions should have similar operating and financial

characteristics and be of similar size

- Recent transactions more accurate than transactions completed in the past

and mind that:

- Transactions are rarely directly comparable

- Transactions may include different synergy rationale

- Public data can be misleading or unavailable

- Acquisition multiples can vary widely

- No current P/E or multiple benchmark


Comparable Transactions’ Multiples

– No specific rules to identify the right multiples It is up to the good

judgment of the analyst.

– Enterprise Value Multiples (in particular EV/EBITDA) are the most used

because not affected by capital structure and accounting policies.

– Time horizon choice

• Last year, current year, current year +1

• Historical average

– Main statistics:

• Average multiple

• Median multiple

• Not consider the highest and the lowest value (extreme values)

6. CONCLUSION

summing-up

MCF - Master in Corporate Finance - SDA Bocconi

Economy & Finance

Transcript of MCF - Master in Corporate Finance - SDA Bocconi