Valuation Part 2: Precedent Transactions Analysis

Precedent transactions analysis, like comparable companies analysis, employs a multiples-based approach to derive an implied valuation range for a given company, division, business, or collection of assets. It is premised on multiples paid for comparable companies in prior M&A transactions.

This method is very similar to comparable companies analysis, however it often implies a higher valuation and multiple range than trading comps for two principal reasons. First, buyers generally pay a "control premium" when purchasing another company. This premium is paid for the ability to control decisions regarding the target's business and its underlying cash flows. Second, strategic buyers (companies in similar industries or PE firms with similar portfolio companies) often have the opportunity to realize synergies, which supports the ability to pay higher multiples. Examples of these synergies are cost savings attributable to combining business operations, growth opportunities, and other financial benefits that occur as a result of the combination of two businesses.

As with comparable companies analysis, we can go about this method via a 5 step approach. We will do the following when building out transaction comps.
1. Select the Universe of Comparable Acquisitions
2. Locate the Necessary Deal-Related and Financial Information
3. Spread Key Statistics, Ratios, and Transaction Multiples
4. Benchmark the Comparable Acquisitions
5. Determine Valuation

Step 1: Selecting the Universe of Comparable Acquisitions requires a strong understanding of the target and its sector. In my internship, I've built out a few different transaction comp screens, so I'll walk you through how I go about it. All bankers use a thing called CapitalIQ, which is basically a database that makes pulling relevant information quick and efficient. I start with setting up a screen for relevant transactions. You generally start with a very broad screening criteria, like geography or industry. Let's say, for example, we're building out a screen for Chipotle. We might start with companies in the United States and Canada. However, in the CapIQ database, we would still probably be looking at 300,000+ precedent transactions. So we will screen again. Let's now do it by industry. The criteria we might use is the "Restaurant" industry, and then we may screen down again for "casual/fast food". At this point, we will have surely narrowed down our list, but we would probably still have too large a list to work with. In order to continue to narrow down our list we will next screen by transaction date. We typically only want to look at transactions that have occurred recently, say, in the last 2-3 years. Next, we might search for key words. Using our Chipotle example, we could use the words, "mexican", "fresh", "organic", "natural", etc. We would vary how descriptive we get based on the number of transactions that result from our screen. Typically, we might want to look at 50 or so, and then further weed some out with more diligence. I actually just performed the exact screen detailed above, and before I started searching for key words, I had 85 transactions to work with. This is do-able, and since I don't want to weed out too many relevant transactions, I will stick with this.

Step 2: Locate the Necessary Deal-Related and Financial Information 
In this step, we seek to locate the financials of the company acquired in a transaction. The sorts of things we are looking for are equity value, enterprise value, revenue, margins, EBIT, EBITDA, and net income. There may be other relevant financial statistics, but these are the main ones we're interested in. This information can be found through CapIQ, or it can be obtained through company SEC filings. It is easy to obtain information on public companies, but it can be incredibly difficult to find this information for private companies.

Step 3: Spread Key Statistics, Ratios, and Transaction Multiples 
In this step, we are simply inputting our financial information into an excel template, and then letting the excel sheet calculate necessary ratios/multiples. The most important multiples are Enterprise Value/LTM sales, EV/LTM EBITDA, and EV/ LTM EBIT. We may also look at an Equity Value multiple or two, for ex. Equity Value/ LTM Net Income.
Below is a picture of a transaction comp set, to get an idea of what I'm talking about. This set is not very thorough, but it gets the point across.

Step 4: Benchmark the Comparable Acquisitions
As with trading comps, the next level of analysis here involves an in depth study of the selected comparable acquisitions to identify those most relevant for valuing the target. As part of the benchmarking, one will want to examine key financial statistics, ratios, and multiples. One will also want to make sure the two businesses are relevant in their operating characteristics and industries. Sticking with the Chipotle example, we may weed out a transaction involving the Cheesecake Factory, and stick with other relevant companies like Taco Bell, Panda Express, etc. (side note: not saying Cheesecake Factory would necessarily be a bad transaction for our comp set, but it's not the most relevant given the operating characteristics of the two cos.)

Once we've benchmarked our comparable acquisitions, we will want to narrow the list down to 10-15 companies. From here we can average the multiples, and begin to determine a valuation for our target company.

Step 5: Determine Valuation
As you can see from the picture posted above, we average out our comp set in the end. In the picture, the median EV/LTM EBITDA multiple is 6.3X, while the mean is 6.5X. The high is 8.5X and the low is 5.5X. So now the question is, how do we use this information to value our company? The rule of thumb is to use a "valuation range". Using this information, we may say that our company X is valued at 6.0-7.0X LTM EBITDA.

How would we factor in unique company characteristics, for example key technology, unique brand loyalty, or incredible growth opportunity? If we observe that our company has one or more unique characteristics which may make it more valuable than its competitors, we might value it at the higher end of the valuation range. In this case, perhaps at 7.0X instead of 6.5X. Admittedly, this is a poor example since the valuation range is so small. Say though, that our valuation range was 13-15X. Valuing a company at 15X EBITDA is considerably higher than a valuation of 13.5X.

Likewise, if a company is less impressive than its competitors, we could value it at the lower end of the valuation range.

IN SUMMARY:
 Precedent transactions analysis is very similar to comparable companies analysis, except with transaction comps we are looking at past M&A transactions, not just companies. Transaction comps also generally implies a higher valuation on a target, because of the "control premium" and "synergies", which can be realized in an acquisition.

As always, feel free to comment with questions. Perhaps sometime soon I'll get around to Valuation Part 3: Discounted Cash Flow Analysis.

Cheers,
EZ

P.S. The virtual portfolio got slammed on Tuesday, but has since gained back most of its losses. Still trying to figure out what to do with it. Perhaps I'll take some off the table, but I'm not sure.