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What is the best way to value a potential acquisition target?

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Valuing a potential acquisition target is one of the most important steps in the deal-making process. It involves estimating how much the target company is worth, based on its current and future performance, assets, liabilities, synergies, and risks. There are different methods and tools to value a target, depending on the type, size, and industry of the business, as well as the availability and quality of data. In this article, we will discuss some of the most common and effective valuation techniques and how to apply them in practice.

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Willy XU

M&A | Philippe Hottinguer Finance
Mounir Dris

Investments management

1 Market multiples

One of the simplest and most widely used valuation methods is to compare the target company with similar companies that are publicly traded or have been recently acquired. This approach relies on the assumption that the market reflects the fair value of comparable businesses, based on certain financial ratios or multiples. Some of the most common multiples are price-to-earnings (P/E), price-to-sales (P/S), price-to-book (P/B), and enterprise value-to-EBITDA (EV/EBITDA). To use this method, you need to identify a set of comparable companies, calculate their average or median multiples, and apply them to the target company's financial metrics. This will give you an estimate of the target company's market value.

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CA Sagar Khatri

Chartered Accountant | Merchant Banker
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How to identify comparable companies? We assume that our business is operating in specific type of sector where many comparable or peer companies exist , so how to identify best match? So first of all compare Top line i.e sales which help to identify best match Then out of that group, analysis the bottom line , if our company have negative PAT or Net income so try to choose Loss making or Minimum profit making peer or if our company is profit making so first find profit margins and then compare it with other peer. This two approach can provide best match to find Enterprise value of our company. We assume that all the other metrics like business model, sector etc. is already match.

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Mounir Dris

Investments management
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In commercial real estate you will need to compare to properties recently sold or rented in the area with pretty similar features such as size, location, clear height or even building condition. Market multiples will then play in when analyzing price by square foot or by cap rate.

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2 Discounted cash flow

Another popular valuation method is to discount the target company's future cash flows to their present value, using an appropriate discount rate. This approach reflects the intrinsic value of the business, based on its expected profitability and growth potential. To use this method, you need to project the target company's free cash flow (FCF) for a certain period, usually five to ten years, and estimate its terminal value (TV), which represents the value of the business beyond the forecast period. Then, you need to discount these cash flows using a weighted average cost of capital (WACC), which reflects the cost and risk of financing the business. The sum of the discounted FCF and TV is the target company's discounted cash flow (DCF) value.

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CA Sagar Khatri

Chartered Accountant | Merchant Banker
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Let’s Understand Free cash flow for firm and free cash flow for equity. > Organisations have two sources of funding one is equity and another one is debt so with this basis we understand differences between FCFF and FCFE. 1. Free cash flow for Firm : In simple words cashflow before deducting Interest, principle repayment and adding new debt . Which means your cashflow includes the value claim by creditors and equity holders of your business. 2. Free cash flow for equity : FCFE is a cash flow after deducting Interest , principal repayment and adding new debt acquire. Which indicate the cashflow only for equity holders.

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3 Asset-based valuation

Another valuation method is to assess the target company's net asset value (NAV), which is the difference between its total assets and total liabilities. This approach reflects the liquidation value of the business, based on its current balance sheet. To use this method, you need to adjust the book value of the target company's assets and liabilities to their fair market value, which may differ from their historical or accounting value. For example, you may need to revalue intangible assets, such as goodwill, patents, or brands, or account for contingent liabilities, such as lawsuits, pensions, or environmental costs. The adjusted NAV is the target company's asset-based value.

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CA Sagar Khatri

Chartered Accountant | Merchant Banker
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Understand NAV deeply: This is a general way of determining a fair value indication of business, business ownership interest, or security by using one or more methods based on the value of the assets of that business net of liabilities. The asset-based approach establishes value based on the cost of reproducing or replacing the property, less depreciation from physical deterioration and functional and economic obsolescence, if present and measurable. The asset-based approach derives an indication of value based on anticipated cost to replace, replicate, or recreate the assets. It is often considered as “Floor” value.

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4 Synergy valuation

Another valuation method is to estimate the value of the potential synergies that the acquirer can achieve by combining with the target company. Synergies are the benefits that result from the merger or acquisition, such as cost savings, revenue enhancement, operational efficiency, or strategic alignment. To use this method, you need to identify and quantify the sources and drivers of synergies, such as economies of scale, cross-selling, market share, technology, or innovation. Then, you need to discount the expected synergy cash flows using a suitable discount rate, which may be lower than the WACC, as synergies are usually less risky than the standalone businesses. The discounted synergy value is added to the standalone value of the target company to get the synergy valuation.

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Willy XU

M&A | Philippe Hottinguer Finance
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La valorisation par le biais des synergies n’est pas pertinente. Payer un premium pour avoir devenir actionnaire majoritaire c’est compréhensible. Valoriser par rapport aux synergies est dépendant de plusieurs facteurs et in fine de la probabilité de leur reussite.

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Willy XU

M&A | Philippe Hottinguer Finance
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La valorisation par le biais des synergies n’est pas pertinente. Payer un premium pour avoir devenir actionnaire majoritaire c’est compréhensible. Valoriser par rapport aux synergies est dépendant de plusieurs facteurs et in fine de la probabilité de leur reussite.

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5 Valuation range and sensitivity

One of the challenges of valuation is to deal with uncertainty and volatility in the market and the business environment. Therefore, it is advisable to use more than one valuation method and to perform sensitivity analysis to test the impact of different assumptions and scenarios on the valuation results. This will help you to establish a valuation range, rather than a single point estimate, and to identify the key value drivers and risk factors that affect the target company's value. A valuation range will also give you more flexibility and confidence in negotiating the deal price and terms with the target company.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Mounir Dris

Investments management
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Consider the exit strategy. In real estate consider these: - Market conditions and future conditions - Investment goals -Property type and location -tax implications -financing and debt and most importantly timing will make or break an exit.

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What is the best way to value a potential acquisition target?

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1 Market multiples

2 Discounted cash flow

3 Asset-based valuation

4 Synergy valuation

5 Valuation range and sensitivity

6 Here’s what else to consider

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