Relative Valuation

Using Market Comparable

Introduction
• A simple method of valuation.
• Uses market prices from observed transaction to propose the value of a
firm.
• The principal of valuation is relatively similar to comparison method
in property valuation.
• In valuing a business, it is based on selected financial ratio or multiple
as basis of comparison.
• The fundamental assumption of this approach is that the “comparable”
transactions are truly comparable to the firm being evaluated.
Multiple Analysis
• Valuation technique must have benefits that exceed its cost of using it.
• A full-fledged fundamental analysis comes at significant cost – it
requires analyst to use large amount of information.
• Involve considerable efforts.
• Multiple analysis however is cheap because it uses minimal information.
• A multiple is simply – ratio of the price to a particular number in the
financial statements – earnings, book values, sales and cash flows.
• Price-earning (P/E) ratio, price-to-book (P/B) ratio, price-to-sales (P/S) ratio,
price-to-cash flow from operation (P/CFO) ratio.
• Multiple analysis provide a basis for the method of comparables.
The Method of Comparable
• The method works as follow:
• Identify comparable companies or firms
• Similar in term of industry its operated in, business operation, size – number of
employee, capitalization, technology, etc.
• Relatively easy and straight forward in some industry but may be challenging in some
others industry.
• Identify measures for the comparable companies.
• Information for financial measures are available in the company financial statement.
• Measures such as earnings, book value, sales, cash flow are used to calculate ratio.
• Apply these multiples to the corresponding measures.
• Based on ratio that has been calculated, it then be applied to the target company.
Example
Firm Sales EBEI Book Market P/S P/E P/B
Value Value
A 45,226 624 13,953 32,963 0.73 52.8 2.4
B 6,080 (1,290) 1,565 1,944 0.32 - 1.2
C 31,168 1,246 4,694 ? ? ? ?

EBEI = Earnings before Extraordinary Items

 Comp. Average C’s Numbers C’s Valuation
Multiple

Sales 0.53 x 31,168 = 16,519

Earnings 52.8* x 1,246 = 65,789
Book Value 1.8 x 4,694 = 8,449
Valuations 30,252
(average)

*for A only since B reported negative earnings.

Comparable Method - Problems
• Comps with similar characteristics are extremely difficult to obtain.
• This the most practical issue – no two firms are exactly similar.
• Firm may be in the same industry; however, they may have various business entity or
different business coverage.
• Although increase the number of comp may average out errors, but more comps there are,
the less homogeneous they are.
• Different multiples produce different valuations.
• Applying comp’s P/B to target firm book value yield different price from applying comp’s
P/E ratio to target’s earning as shown in the example.
• Which price to use?
• In the example, it simply use arithmetic average – but it is not clear whether it is correct.
• Negative denominators can occur.
Firm Value Using EBITDA Multiples
• EBITDA = Earning Before Interest Taxation Depreciation and
Amortization.
• One of the popular approaches used by professionals to estimate the
enterprise value.
• EBITDA is a crude measure of a firm cash flow.
• EBITDA multiple is analogous to to cash flow multiple used in real
estate valuation.
Enterprise Value (EV)
• EV = sum of values of the firm’s interest-bearing debt and it’s equity minus the
firm’s cash balance
• August 2005, Airgas Inc (ARG) had EV of $2.96 bill consist of the following
components:
Elements of firm’s balance sheet Values
Non-interest-bearing debt 669,056,000
Interest-bearing debt (short- and long-term) 808,635,000
Common equity (MV = price per share x shares outstanding) 2,180,000,000
FIRM VALUE 3,657,691,000
Less: Non-interest-bearing debt (669,056,000)
Less: Cash and equivalents (32,640,000)
ENTERPRISE VALUE 2,955,995,000
• Equity value can be calculated from EV as follow:
• Owner’s Equity = EV – (Interest-bearing debt – Cash)
• = EV – Net Debt
• The Airgas EBITDA Multiple
• EVAirgas2005 = EBITDAAirgas2005 x EBITDAMultiple
• EBITDAMultiple = EV / EBITDA = 2,955,995 / 340,000,000 = 8.69
EBITDA Multiple – Application with
Example
• Helix Corp – a privately owned company with a potential for acquisition.
• Since it is privately owned, acquirer cannot observe its MV directly.
• However, acquirer may use similar firms that is publicly traded to infer Helix
value by using appropriate EBITDA valuation ratio.
• First, identify comparable firms to compute appropriate EBITDA multiple
and then apply to HELIX’s EBITDA to get initial estimate of EV.
• Next, refining estimate of both the EBITDA multiple and the firm’s EBITDA.
• Constitute careful assessment of basic elements of the valuation (EBITDA and
EBITDA multiple or valuation ratio)
• To tailor the analysis to the specific firm that is being valued.
• Helix is a regional supplier of specialty gases including nitrogen, oxygen,
argon, helium, etc.
• 4 national firms has been identified that constitute the primary competitors to Helix.
• These are Air Products (APD), Airgas (ARG), Praxair (PX), and Applied Industrial
Technologies (AIT).
• Most recent EBITDA need to be identified for these firms.
($ million) Air Products Praxair Inc Applied Industrial Airgas Average
Technologies Inc.
Enterprise Value 16,100 19,450 1,080 2,996

EBITDA 1,390 1,810 99 340

EBITDA multiple 11.58 10.75 10.91 8.81 10.51

Normalizing EBITDA
• 2nd phase of valuation process – tailoring the analysis to Helix.
• Need to make adjustment on the figures.
• EBITDA does not vary over time – may be influenced by idiosyncratic
effect.
• Effect such as non-recurring special event (one time event) or one time
transaction that inflate earning in that time period.
• Such event need to purge from earning before calculating EBITDA multiple.
• If such a thing happen, downward adjustment is needed.
Adjusting Ratio for Liquidity Discounts and
Control Premiums
• Value calculated is not necessarily the price buyer would be willing to
pay.
• Price depends on type of buyer.
• Financial buyer – determine price based on analysis of acquisition
• Strategic buyer – price based on the other business they own: synergy – they
often pay more than financial buyer.
• In Helix example, it is a privately held business and the comparison
use in the analysis are publicly held companies.
• Private company often sell at discount compare to public company due to
liquidity issue.
• A discount between 20% to 30% is typical
• Let’s do the calculation
• Enterprise Value (revised): $10 mill (1 – 0.3) x 10.51 = 73,357,000
• Plus: Cash = 2,400,000
• Less: Interest-bearing debt = (21,000,000)
• Equity Value = $54,970,000
• Another aspect is the control premium.
• If one of the public company decide to acquire Helix, as part of its strategic
acquisition, the amount of strategic premium depends on the bargaining
position of the buyer and seller.
Some Exercise:
• ABC Retail Inc. is a clothing retailer operating in a highly competitive market. You have collected financial
information and valuation multiples for three comparable companies in the same industry. The following
table presents the financial data and valuation multiples:

Company X Company Y Company Z ABC Retail Inc.

Revenue $5 million $8 million $6 million $4 million
EBIT $500,000 $750,000 $600,000 $400,000
Net Income $300,000 $400,000 $350,000 $250,000
Book Value of $2 million $2.5 million $2.2 million ?
Equity
• Using the relative valuation method, calculate the estimated book value of equity for ABC Retail
Inc. based on the valuation multiples of the comparable companies. The average valuation
multiples for the comparable companies are as follows:
• Price-to-Sales (P/S) ratio: 0.8x
• Price-to-EBIT (P/EBIT) ratio: 6x

• Assume that the P/S ratio and P/EBIT ratio can be applied to estimate the book value of equity for
ABC Retail Inc.
• Based on the given information and using the relative valuation method, what is the estimated
book value of equity for ABC Retail Inc.?