The Valuation Football Field !

The Valuation Football Field

Author: Drs. J.J.P. (Joris) Kersten RAB

Kersten Corporate Finance

25th December 2021, Uden/ The Netherlands

?

Kersten Corporate Finance

I am an independent M&A consultant from The Netherlands.

Together with my 2 full time, and soon 3 full time, M&A Analysts Mr. Soufian and Mr. Anas we buy and sell SMEs (small & medium sized companies) in The Netherlands.

These companies have an enterprise value of typically in between 1 million and 25 million euro enterprise value.

On top of that I provide training in valuation all over the globe, this at leading “bulge bracket” investment banks in New York, London and Hong Kong. But also at Universities all over the globe, for example in Surinam, Mongolia, Peru, Kuwait, Saudi Arabia etc.

And in the Netherlands I provide twice a year a 6-day valuation training (financial modelling), the next one is: 6 April 2022 until 12 April 2022.

M&A?consulting: www.kerstencf.nl

Valuation training: www.joriskersten.nl

?

The Valuation Football Field

With valuation we generally look at 4 different ways to value a company.

These methods are:

1.??????Comparable company analysis (CCA);

2.??????Precedent transaction analysis (PTA);

3.??????Discounted cash flow valuation (DCF);

4.??????Leveraged buyout analysis (LBO).

On top of that we use so called “M&A modelling” to check whether a deal is “accretive” or “dilutive”.

The 4 ways to value a company provide us with ranges, and we put these ranges in a table which looks like a football field, that’s why we talk about the “valuation football field”.

Let’s look at the different methods in a little more detail.

?

Comparable company analysis (CCA) + Precedent transaction analysis (PTA)

With CCA or popularly said “comps” we look at similar companies when we want to valuate a certain privately held target company.

So we basically compare our target company with lookalike companies listed on the stock exchange.

Because from these listed lookalike companies we can determine the “market cap” by multiplying their fully diluted number of shares times the market price of a share.

On top of that we can determine the market value of debt, basically the value of for example the term loans and bonds.

The market cap + market value of debt roughly equals: Enterprise value (EV).

And when we divide EV by the EBITDA cleaned for “one offs” (cleaned EBITDA), we then have the EBITDA multiple of a few “comps”. ?

With PTA we roughly do the same, but then we study precedent M&A deals to get EBITDA multiples for valuation.

?

Discounted cash flow valuation (DCF)

With DCF we study the free cash flows (FCFs) of a target, these basically are the cash flows that are there for both the debt holders and the equity holders.

It basically is the EBIT -/- corporate tax + deprecation/ amortisation -/- CAPEX and working capital adjustments.

And then we discount these FCFs with a discount rate that represents the risk involved in the company.

Also this way we get to a EV of the company. This method is probably the most used method to value companies all over the globe.

?

Leveraged buyout analysis (LBO)

With LBO analyses we also look at FCFs, but then we “use” the FCFs to pay down the debt in the acquisition.

So with LBO analysis we also need to build a so called debt schedule to assess the level of debt in a company.

Maybe you remember that the EV is a multiple over EBITDA, and then we subtract the level of debt in the company to arrive at “value of the shares”.

With LBO analysis we yearly measure the expected EBITDA, so yearly we can calculate the EV when we also estimate a EBITDA multiple.

On top of that we measure the level of debt in the company yearly, so also yearly we can take the expected EV and minus debt to get a value of shares.

When we have the value of the shares when we buy a company, and when we have the value of the shares in let’s say 5 years, we can then calculate the “IRR” (internal rate of return) on “equity in” and “equity out” really easy.

So with LBO analysis we measure the IRR and credit statistics and we can calculate backwards what the value of the company is (the max price to pay), when we want to have an IRR on equity of for example 20%.

?

M&A modelling

After CCA, PTA, DCF and LBO analysis we want to know whether a deal is “accretive” or “dilutive”.

A deal is accretive when the EPS (earnings per share) of the buyer goes up after the deal.

When a buyer buys a company for a higher EBITDA multiple than for which it is valued itself, then the deal is 100% for sure dilutive when it is financed “all equity”.

This because the buyer needs to raise equity for a lower value than for which it buys the target. This because the target has a higher EBITDA multiple.

Of course this happens a lot, so the trick is then to use debt in the deal, this way a deal can still become “EPS accretive”, because cheap debt can be used to increase the EPS after the deal. This is just the result of “financial leverage”, so classic leverage.

Only remember that buyers can not raise debt without paying the price for it: A decreasing “credit statistic” (by Moody’s/ S&P/ Fitch) because of the weaker balance sheet you create with adding debt.

Another trick to get a “dilutive deal”, when buying a high multiple target company, to a “accretive deal” is to come up with "synergies" in the COGS, SG&A or even revenues after the deal.

This way you can increase the net profits after the deal (because of cost synergies or revenue synergies), and this obviously increases the EPS after the deal, which can make the deal EPS accretive.

To make a long story short, you use CCA, PTA, DCF and LBO analysis to come up with a EV to pay in a deal.

At last you check with a M&A model whether the deal is accretive when you pay the EV with a certain "debt & equity mix" + when you estimate certain synergies.

And deals really need to be accretive in the upcoming future, because financial markets do NOT like dilutive deals !

?

End,

We wish our network Happy holidays and a successful New Year !!