Valuation Multiples - Part 1

Inherent in all valuation methodologies is the idea of a “multiple”. A multiple is simply a ratio of value to a financial statement statistic such as Revenue, EBITDA, and EBIT and Price / Earnings (PE) multiple. For example, the PE multiple is a multiple of earnings; however, there are numerous other multiples, such as Revenue, EBITDA, and EBIT multiples. Generally speaking, the name of the multiple is simply the denominator of the ratio; the numerator will vary according to the denominator.

For purposes of valuing entities that are “cash-based” businesses (such as an insurance brokerage), a multiple of EBITDA is typically utilized. EBITDA is an accounting term that is defined as Earnings Before Interest, Taxes, Depreciation, and? Amortization and is sometimes used as a proxy for cash flow. However, depending on the industry, other multiples are also?important. For example, during the Technology boom, revenue multiples were crucial for valuing and benchmarking unprofitable businesses. Also, in the insurance industry, Price / Book multiples are typically used to value insurance companies because of the relative stability of book value.

Multiples are either forward-looking or backward-looking: backward-looking multiples, or “trailing” multiples, use statistics that have been realized, such as last full year earnings or a last twelve months (LTM) statistic. For example, if a stock price is $20? per share and last year’s earnings per share (EPS) was $1, the PE is 20 /1 ? 20x. Forward-looking multiples, or simply “forward” multiples, use estimates. For example, if a stock price is $20 and is estimated to have an EPS of $2 this year, the PE is? 20/2 ? 10x. Thus, it’s important to clarify not just the multiple, but also exactly what is being measured within that multiple.?

In general, the higher the multiple, the higher the value ascribed to future earnings or cash flow of a company; in other words,?

the higher the multiple, the more an investor is paying for the stock or the company. A higher multiple is usually attributed to younger, high-growth companies whereas a lower multiple can be attributed to a mature, slow growth or negative growth of the company.? If a company’s LTM EBITDA was $100 million and if comparable companies were trading at a 7x EBITDA multiple, the company would have an implied value of $100 million x 7x = $700 million based on an LTM or trailing basis. EBITDA?

multiple ranges are based on either comparable publicly traded companies or past transactions of similar companies. This provides a valuation range based on the market’s perception of the growth potential and profitability of “similar” publicly traded companies at a given point in time.

The following steps and methodologies would be applied using a multiples approach:?

? Review historical numbers to understand operating performance?

? Perform adjustments to the latest twelve-month (LTM) results to arrive at “Pro Forma” results that depict the core profitability or a natural run rate of the company

? Determine a range of values usually based on a multiple of EBITDA?

? Balance sheet adjustments are made to values such as excess cash, working capital requirements, contingent assets, liabilities, etc?