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Using a step-by-step how-to approach for eachmethodology, the authors build a chronological knowledge base anddefine key terms, financial concepts, and processes throughout thebook. This involves theuse of more realistic assumptions governing approach to risk aswell as a wide range of value drivers.
While valuation has alwaysinvolved a great deal of "art" in addition to time-tested"science," the artistry is perpetually evolving in accordance withmarket developments and conditions. As a result, Rosenbaum andPearl have updated the widely adopted first edition of their bookwith respect to both technical valuation fundamentals as well aspractical judgment skills and perspective.
Furthermore, the authors address the importance of rigorousanalysis based on trusted and attributable data sources. In thisbook, they highlight several datasets and investment banking toolsfrom Bloomberg, a leading provider of business and financial data, news, research, and analytics. Mastery of theseessential skills is fundamental for any role in transaction-relatedfinance. This book will become a fixture on every financeprofessional's bookshelf. As such, their book is an essential resourcefor understanding complex businesses and capital structures whetheryou are on the buy-side or sell-side.
Rosenbaum and Pearl have drawn from their broad deal experience andextensive network to create the best valuation and deal guidebookin the world. While numerous textbooks provide students with thecore principles of financial economics, the rich institutionalconsiderations that are essential on Wall Street are not welldocumented. This book represents an important step in filling thisgap.
The book is written from theperspective of practitioners, setting it apart from othertexts. Each model comes complete with a user's guide. Using a step-by-step how-to approach for each methodology, the authors build a chronological knowledge base and define key terms, financial concepts, and processes throughout the book. This involves the use of more realistic assumptions governing approach to risk as well as a wide range of value drivers. While valuation has always involved a great deal of "art" in addition to time-tested "science," the artistry is perpetually evolving in accordance with market developments and conditions.
As a result, Rosenbaum and Pearl have updated the widely adopted first edition of their book with respect to both technical valuation fundamentals as well as practical judgment skills and perspective. Furthermore, the authors address the importance of rigorous analysis based on trusted and attributable data sources. In this book, they highlight several datasets and investment banking tools from Bloomberg, a leading provider of business and financial data, news, research, and analytics.
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Page 1 of 1 Start over Page 1 of 1. Joshua Rosenbaum. Only 4 left in stock. Investment Banking Workbook: Wiley Finance. Matt Krantz. Only 3 left in stock. Customers who viewed this item also viewed. Benjamin Graham. See all free Kindle reading apps. Don't have a Kindle? Even these sub-sectors can be further segmented—for example, chemicals can be divided into specialty and commodity chemicals.
For companies with distinct business divisions, the segmenting of comparable companies by sub-sector may be critical for valuation. On the other hand, cyclical or highly fragmented sectors may present growth opportunities that are unavailable to companies in more stable or consolidated sectors. Accordingly, companies that produce similar products or provide similar services typically serve as good comparables.
Products are commodities or value-added goods that a company creates, produces, or refines. Examples of products include computers, lumber, oil, prescription drugs, and steel. Services are acts or functions performed by one entity for the benefit of another.
Examples of common services include banking, consulting, installation, lodging, and transportation. Many companies provide both products and services to their customers, while others offer one or the other. Within a given sector or sub-sector, comparable companies may be tiered according to their products and services. For example, within the chemicals sector, specialty chemicals producers tend to consistently trade at a premium to commodity chemicals producers.
Hence, they are often grouped together in a tighter comparables category within the broader chemicals universe. The same holds true for the commodity players. Companies with a similar customer base tend to share similar opportunities and risks.
For example, companies supplying automobile manufacturers abide by certain manufacturing and distribution requirements, and are subject to the automobile purchasing cycles and trends. Some companies serve a broad customer base while others may target a specialized or niche market. For example, a plastics manufacturer may sell into several end markets, including automotive, construction, consumer products, medical devices, and packaging.
End markets need to be distinguished from customers. For example, a company may sell into the housing end market, but to retailers or suppliers as opposed to homebuilders. A company that sells products into the housing end market is susceptible to macroeconomic factors that affect the overall housing cycle, such as interest rates and unemployment levels. Therefore, companies that sell products and services into the same end markets generally share a similar performance outlook, which is important for determining appropriate comparable companies.
Distribution Channels Distribution channels are the avenues through which a company sells its products and services to the end user. As such, they are a key driver of operating strategy, performance, and, ultimately, value. Companies that sell primarily to the wholesale channel, for example, often have significantly different organizational and cost structures from those selling directly to retailers or end users. Selling to a superstore or value retailer requires a physical infrastructure, sales force, and logistics that may be unnecessary for serving the professional or wholesale channels.
Some companies sell at several levels of the distribution chain, such as wholesale, retail, and direct-to-customer. A flooring manufacturer, for example, may distribute its products through selected wholesale distributors and retailers, as well as directly to homebuilders and end users.
Geography Companies that are based in and sell to different regions of the world often differ substantially in terms of fundamental business drivers and characteristics. These may include growth rates, macroeconomic environment, competitive dynamics, path s -to- market, organizational and cost structure, and potential opportunities and risks. Such differences—which result from local demographics, economic drivers, regulatory regimes, consumer buying patterns and preferences, and cultural norms—can vary greatly from country to country and, particularly, from continent to continent.
Consequently, there are often valuation disparities for similar companies in different global regions or jurisdictions. For example, a banker seeking comparable companies for a U. Even in these instances, however, valuation disparities by geography are often evident. Financial Profile Key financial characteristics must also be examined both as a means of understanding the target and identifying the best comparable companies.
Size Size is typically measured in terms of market valuation e. Companies of similar size in a given sector are more likely to have similar multiples than companies with significant size discrepancies. This reflects the fact that companies of similar size are also likely to be analogous in other respects e.
Consequently, differences in size often map to differences in valuation. Hence, the comparables are often tiered based on size categories. This tiering, of course, assumes a sufficient number of comparables to justify organizing the universe into sub-groups. Equity investors reward high growth companies with higher trading multiples than slower growing peers.
They also discern whether the growth is primarily organic or acquisition-driven, with the former generally viewed as preferable. For early stage or emerging companies with little or no earnings, however, sales or EBITDA growth trends may be more relevant. ROI ratios employ a measure of profitability e.
At the initial stage, the focus is on identifying companies with a similar business profile. While basic financial information e. Investment banks generally have established lists of comparable companies by sector containing relevant multiples and other financial data, which are updated on a quarterly basis and for appropriate company-specific actions.
Often, however, the banker needs to start from scratch. Competitors generally share key business and financial characteristics and are susceptible to similar opportunities and risks. Public companies typically discuss their primary competitors in their Ks, annual proxy statement DEF14A ,10 and, potentially, in investor presentations.
The fairness opinion is supported by a detailed overview of the methodologies used to perform a valuation of the target, typically including comparable companies, precedent transactions, DCF analysis, and LBO analysis, if applicable. This type of screen is typically used either to establish a broad initial universe of comparables or to ensure that no potential companies have been overlooked.
Sector reports published by the credit rating agencies e. In addition to the aforementioned, senior bankers are perhaps the most valuable resources for determining the comparables universe. Given their sector knowledge and familiarity with the target, a brief conversation is usually sufficient for them to provide the junior banker with a strong starting point.
Toward the end of the process—once the junior banker has done the legwork to craft and refine a robust list of comparables—a senior banker often provides the finishing touches in terms of more nuanced additions or deletions. At this stage of the process, there may be sufficient information to eliminate certain companies from the group or tier the selected companies by size, business focus, or geography, for example.
The most common sources for public company financial data are SEC filings such as Ks, Qs, and 8-Ks , as well as earnings announcements, investor presentations, equity research reports, consensus estimates, and press releases, each of which are available via Bloomberg. A summary list of where to locate key financial data is provided in Exhibit 1. Depending on the sector and point in the cycle, however, financial projections tend to be more meaningful.
Estimates for forward-year financial performance are typically sourced from consensus estimates such as Bloomberg BEst estimates see Appendix 1. It also contains an abundance of other pertinent information about the company and its sector, such as business segment detail, customers, end markets, competition, insight into material opportunities and challenges and risks , significant recent events, and acquisitions.
For the purposes of spreading trading comps, the annual proxy statement provides a basic shares outstanding count that may be more recent than that contained in the latest K or Q. As previously discussed, the annual proxy statement also typically contains a suggested peer group for benchmarking purposes. Equity Research Research Reports Equity research reports provide individual analyst estimates of future company performance, which may be used to calculate forward-looking multiples.
These reports may also provide segmented financial projections, such as sales and EBIT at the business division level. Initiating coverage research reports tend to be more comprehensive than normal interim reports. As a result, it is beneficial to mine these reports for financial, market, and competitive insights.
Consensus Estimates Consensus research estimates for selected financial statistics are widely used by bankers as the basis for calculating forward-looking trading multiples in trading comps. Earnings announcements, which are accompanied by the filing of an 8-K, are typically issued prior to the filing of a K or Q.
Therefore, the banker relies upon the financial data provided in the earnings announcement to update trading comps in a timely manner. In the event that certain financial information is not provided in the earnings press release, the banker must wait until the filing of the K or Q for complete information. Financial Information Services As discussed throughout this section, Bloomberg is a key source for obtaining SEC filings, research reports, consensus estimates, and press releases, among other items.
Bloomberg Coverage Dashboard summarizes information for investment bankers to monitor and diligence public companies see Appendix 1. We also describe the mechanics for calculating LTM financial statistics, calendarizing company financials, and adjusting for non-recurring items and recent events.
Calculation of Key Financial Statistics and Ratios In this section, we outline the calculation of key financial statistics, ratios, and other metrics in accordance with the financial profile framework introduced in Step I. This is a widely used metric that provides perspective on valuation and gauges current market sentiment and outlook for both the individual company and its broader sector. For example, a company may have missed its earnings guidance or underperformed versus its peers over the recent quarter s.
It may also be a sign of more entrenched issues involving management, operations, or specific markets. In some cases, however, the latest proxy statement may contain more updated data and, therefore, should be used in lieu of the K or Q. This results in a net issuance of shares, which is dilutive.
In Exhibit 1. To calculate net new shares, the 4. Convertible and Equity-Linked Securities Outstanding convertible and equity-linked securities also need to be factored into the calculation of fully diluted shares outstanding.
Convertible and equity-linked securities bridge the gap between traditional debt and equity, featuring characteristics of both. They include a broad range of instruments, such as traditional cash-pay convertible bonds, convertible hybrids, perpetual convertible preferred, and mandatory convertibles. The value of the embedded call option allows the issuer to pay a lower coupon than a straight debt instrument of the same credit.
Cash-pay converts are converted into additional shares in accordance with either the if-converted method physical settlement or net share settlement, as applicable. Out-of- the-money converts, by contrast, remain treated as debt. As shown in Exhibit 1. This amount must be tax-effected before being added back to net income. Therefore, while conversion is typically EPS dilutive due to the additional share issuance, net income is actually higher on a pro forma basis.
For converts issued with a net share settlement accounting feature,35 the issuer is permitted to satisfy the face or accreted value of an in-the-money convert with at least a portion of cash upon conversion. Only the value represented by the excess of the current share price over the conversion price is assumed to be settled with the issuance of additional shares,36 which results in less share issuance. This serves to limit the dilutive effects of conversion by affording the issuer TSM accounting treatment.
As the graphic in Exhibit 1. The equity value component is calculated on a fully diluted basis. For example, if a company raises additional debt that is held on the balance sheet as cash, its enterprise value remains constant as the new debt is offset by the increase in cash i. Similarly, if a company issues equity and uses the proceeds to repay debt, the incremental equity value is offset by the decrease in debt on a dollar- for-dollar basis see Scenario II in Exhibit 1.
Hence, similar companies would be expected to have consistent enterprise value multiples despite differences in capital structure. One notable exception concerns highly leveraged companies, which may trade at a discount relative to their peers due to the perceived higher risk of financial distress40 and potential constraints to growth. Sales represents the total dollar amount realized by a company through the sale of its products and services during a given time period.
All else being equal, companies with greater sales volumes tend to benefit from scale, market share, purchasing power, and lower risk profile, and are often rewarded by the market with a premium valuation relative to smaller peers. Gross Profit, defined as sales less cost of goods sold COGS ,41 is the profit earned by a company after subtracting costs directly related to the production of its products and services.
As such, it is a key indicator of operational efficiency and pricing power, and is usually expressed as a percentage of sales for analytical purposes gross profit margin, see Exhibit 1. EBITDA earnings before interest, taxes, depreciation and amortization is an important measure of profitability. Wall Street tends to view net income on a per share basis i.
These costs are typically largely variable, as opposed to corporate overhead, which is more fixed in nature. Accordingly, they are used to frame relative performance both among peer companies and across sectors. It is net of interest expense and, therefore, affected by capital structure. As a result, companies with similar operating margins may have substantially different net income margins due to differences in leverage.
Furthermore, as net income is impacted by taxes, companies with similar operating margins may have varying net income margins due to different tax rates. As with the calculation of any financial statistic, historical EPS must be adjusted for non-recurring items to be meaningful. Return on Investment Return on invested capital ROIC measures the return generated by all capital provided to a company.
ROE is an important indicator of performance as companies are intently focused on shareholder returns. ROA typically utilizes net income in the numerator and average total assets in the denominator see Exhibit 1.
Dividend yield measures the annual dividends per share paid by a company to its shareholders which can be distributed either in cash or additional shares , expressed as a percentage of its share price. Dividends are typically paid on a quarterly basis and, therefore, must be annualized to calculate the implied dividend yield see Exhibit 1. It is generally calculated on the basis of LTM financial statistics.
This ratio can be calculated on the basis of book or market values depending on the situation. As with debt-to-EBITDA, a higher debt-to-total capitalization ratio connotes higher debt levels and risk of financial distress. Coverage ratios are generally comprised of a financial statistic representing operating cash flow e. Intuitively, the higher the coverage ratio, the better positioned the company is to meet its debt obligations and, therefore, the stronger its credit profile.
Credit ratings are typically required for companies seeking to raise debt financing in the capital markets as only a limited class of investors will participate in a corporate debt offering without an assigned credit rating on the new issue. The ratings scales of the primary rating agencies are shown in Exhibit 1.
As previously discussed, however, prior to the filing of the Q or K, companies typically issue a detailed earnings press release in an 8-K with the necessary financial data to help calculate LTM performance. As the formula in Exhibit 1. Exhibit 1. Some companies, however, report on a different schedule e. Any variation in fiscal year ends among comparable companies must be addressed for benchmarking purposes.
Failure to do so may lead to the calculation of misleading ratios and multiples, which, in turn, may produce a distorted view of valuation. These adjustments involve the add-back or elimination of one-time charges and gains, respectively, to create a more indicative view of ongoing company performance.
Typical charges include those incurred for restructuring events e. Typical benefits include gains from asset sales, favorable litigation settlements, and tax adjustments, among others. Research reports can be helpful in identifying these items, while also providing color commentary on the reason they occurred. In many cases, however, the banker must exercise discretion as to whether a given charge or benefit is non-recurring or part of normal business operations. This determination is sometimes relatively subjective, further compounded by the fact that certain events may be considered non-recurring for one company, but customary for another.
For example, a generic pharmaceutical company may find itself in court frequently due to lawsuits filed by major drug manufacturers related to patent challenges. In this case, expenses associated with a lawsuit should not necessarily be treated as non- recurring because these legal expenses are a normal part of ongoing operations.
While financial information services such as Bloomberg provide a breakdown of recommended adjustments that can be helpful in identifying potential non-recurring items, ultimately the banker should exercise professional judgment. When adjusting for non-recurring items, it is important to distinguish between pre-tax and after-tax amounts.
To calculate adjusted net income, however, the pre-tax restructuring charge needs to be tax-effected50 before being added back. Therefore, prior to performing trading comps, the banker checks company SEC filings e. Therefore, the banker can use updated consensus estimates in combination with the pro forma balance sheet to calculate forward-looking multiples.
While various sectors may employ specialized or sector-specific valuation multiples see Exhibit 1. For equity value or share price multiples, the denominator must be a financial statistic that flows only to equity holders, such as net income or diluted EPS. The following sections provide an overview of the more commonly used equity value and enterprise value multiples. For example, it is not relevant for companies with little or no earnings as the denominator in these instances is de minimis, zero, or even negative.
In addition, as previously discussed, net income and EPS is net of interest expense and, therefore, dependent on capital structure. Sales may provide an indication of size, but it does not necessarily translate into profitability or cash flow generation, both of which are key value drivers. Selected examples are shown in Exhibit 1.
Appendix 1. Benchmarking centers on analyzing and comparing each of the comparable companies with one another and the target. The closest comparables are generally those most similar to the target in terms of business and financial profile. We have broken down the benchmarking exercise into a two-stage process. Second, we analyze and compare the trading multiples for the peer group, placing particular emphasis on the best comparables.
Benchmark the Financial Statistics and Ratios The first stage of the benchmarking analysis involves a comparison of the target and comparables universe on the basis of key financial performance metrics. These metrics, as captured in the financial profile framework outlined in Steps I and III, include measures of size, profitability, growth, returns, and credit strength.
They are core value drivers and typically translate directly into relative valuation. The results of the benchmarking exercise are displayed on spreadsheet output pages that present the data for each company in an easy-to-compare format see Exhibits 1. Is the company a market leader or laggard, gaining or losing market share? Has the company been successful in delivering upon announced strategic initiatives or meeting earnings guidance?
Benchmark the Trading Multiples The trading multiples for the comparables universe are also displayed on a spreadsheet output page for easy comparison and analysis see Exhibit 1. This enables the banker to view the full range of multiples and assess relative valuation for each of the comparable companies. Depending on the resulting output, it may become apparent that certain outliers need to be excluded from the analysis or that the comparables should be further tiered e.
The trading multiples for the best comparables are also noted as they are typically assigned greater emphasis for framing valuation. STEP V. The banker typically begins by using the means and medians of the most relevant multiple for the sector e. The high and low multiples of the comparables universe provide further guidance.
The multiples of the best comparables, however, are typically relied upon as guideposts for selecting the tightest, most appropriate range. Consequently, as few as two or three carefully selected comparables often serve as the ultimate basis for valuation, with the broader group providing reference points.
Hence, the selected multiple range is typically tighter than that implied by simply taking the high and low multiples for the universe. As part of this exercise, the banker must also determine which period financial data is most relevant for calculating the trading multiples. Depending on the sector, point in the business cycle, and comfort with consensus estimates, the comparable companies may be trading on the basis of LTM, one-year forward, or even two-year forward financials.
As shown in the illustrative example in Exhibit 1. For public companies, the implied equity value is then divided by fully diluted shares outstanding to yield implied share price. As with the example in Exhibit 1.
Implied Share Price For a public company, the banker typically begins with net income and builds up to implied equity value. The implied equity value is then divided by fully diluted shares outstanding to calculate implied share price.
The banker should also compare the valuation derived from comparable companies to other methodologies, such as precedent transactions, DCF analysis, and LBO analysis if applicable. Significant discrepancies may signal incorrect assumptions, misjudgment, or even mathematical error, thereby prompting the banker to re-examine the inputs and assumptions used in each technique. Common errors in trading comps typically involve the inclusion or over- emphasis of inappropriate comparable companies, incorrect calculations e.
For the purposes of Chapters 1 through 6, we assume that ValueCo is a private company and that the financial statistics and valuation multiples throughout the book represent normalized economic and market conditions. Step I.
Therefore, we were provided with substantive information on the company, its sector, products, customers, competitors, distribution channels, and end markets, as well as historical financial performance and projections. We sourced this information from the confidential information memorandum CIM, see Exhibit 6.
These sources provided us with enough information to create a solid initial list of comparable companies see Exhibit 1. Locate the Necessary Financial Information In Step II, we set out to locate the financial information necessary to spread the key financial statistics and ratios for each of the companies that we identified as being comparable to ValueCo. For Gasparro Corp. Additional financial information was sourced from Bloomberg.
Specifically, these filings provided us with the prior year annual as well as current and prior year YTD financial statistics necessary to calculate LTM data. Spread Key Statistics, Ratios, and Trading Multiples After locating the necessary financial information for the selected comparable companies, we created input sheets for each company, as shown in Exhibit 1.
These input sheets link to the output pages used for benchmarking the comparables universe see Exhibits 1. Gasparro Corp. As the trading multiples benchmarking output page shows see Exhibit 1. We searched recent press releases and SEC filings to ensure that no stock splits, follow-on offerings, or major share buybacks, for example, took place following the most recent Q filing.
We also confirmed that Gasparro does not have convertible securities outstanding. However, Gasparro has several tranches of options, which must be reflected in the calculation of fully diluted shares in accordance with the TSM. The first tranche, for example, represents a group of options collectively owning the right to buy 1. Consequently, these options were excluded from the calculation of fully diluted shares outstanding.
In aggregate, the 2. The repurchased shares are then subtracted from the 2. This calculated equity value forms the basis for calculating enterprise value. The adjusted financial statistics then served as the basis for calculating the various LTM profitability ratios, credit statistics, and trading multiples used in the benchmarking analysis see Exhibits 1. We also calculated free cash flow FCF by subtracting capex from cash from operations for each reporting period.
This enabled us to calculate a FCF-to-sales margin of 6. We checked recent press releases to ensure there were no changes in dividend policy after the filing of the Q. This provided a debt-to-total capitalization ratio of This provided a total leverage multiple of 2. This provided a ratio of 9. These estimates, along with the calculated enterprise and equity values, were used to calculate forward trading multiples.
For historical data, we used the adjusted income statement financials from Exhibit 1. This benchmarking analysis, in combination with a review of key business characteristics outlined in Exhibit 1. These closest comparables were instrumental in helping to frame the ultimate valuation range. In this case, we did not eliminate the outliers altogether. As previously discussed, financial performance typically translates directly into valuation i.
Many equity investors focus primarily on free cash flow generation for their valuation and investment decisions. Determine Valuation The means and medians for the Specialty Chemicals comparables universe helped establish an initial valuation range for ValueCo, with the highs and lows providing further perspective. To fine-tune the range, however, we focused on those comparables deemed closest to ValueCo in terms of business and financial profile—namely, BuyerCo, Gasparro Corp.
We also looked at the implied valuation based on a range of 7. This implied valuation range is typically displayed in a format such as that shown in Exhibit 1. Determine Valuation V. Benchmark the Comparable Companies A. Sector II. Return on investment III. End markets IV. Distribution channels V. Return on assets A. I and III B. II and IV C. Customers II. Profitability III.
Growth profile IV. Credit profile V. Investor Presentations D. Equity Research 5 Which of the following is the correct calculation for fully diluted shares outstanding when used in trading comps? Treasury Stock Method B. Net Share Settlement Method D. Stays constant B. Increases C. Decreases D. EBIT C. SEC filings can be located online at www. An initiating coverage equity research report refers to the first report published by an 11 equity research analyst beginning coverage on a particular company.
This report often provides a comprehensive business description, sector analysis, and commentary. Not all companies are LBO candidates. It also contains forward-looking information about the possible future effects of known and unknown events, conditions, and trends.
Regulation FD Fair Disclosure provides that when a public filer discloses material 24 nonpublic information to certain persons, as defined by the SEC, it must make public disclosure of that information typically through the filing of an 8-K. For example, if a company has recently made a transformative acquisition, some analysts may have revised their estimates accordingly, while others may have not.
Bloomberg and other sources allow the banker to view individual estimates and the date when they were posted , which allows for the identification and removal of inconsistent estimates as appropriate. Access to these websites requires a subscription. Employee stock options are subject to vesting periods that restrict the number of shares available for exercise according to a set schedule. For conservatism i. While the overall volume of issuance for convertible and equity-linked securities is 33 much less than that for straight debt instruments, they are relatively common in certain sectors.
First, the issuer needs to test the security as if it were debt on its balance sheet, with the stated interest expense reflected in net income and the underlying shares omitted from the share count. Second, the issuer needs to test the security as if it were converted into equity, which involves excluding the interest expense from the convert in net income and including the full underlying shares in the share count.
Upon completion of the two tests, the issuer is required to use the more dilutive of the two methodologies. These changes effectively bifurcate an NSS convert into its debt and equity components, resulting in higher reported GAAP interest expense due to the higher imputed cost of debt. However, the new guidelines do not change the calculation of shares outstanding in accordance with the TSM. Therefore, one should consult with a capital markets specialist for accounting guidance on in-the-money converts with NSS features.
The NSS feature may also be structured so that the issuer can elect to settle the excess 36 conversion value in cash. See Chapter 4: Leveraged Buyouts for additional information. As the perceived risk of financial distress increases, equity value generally decreases accordingly. Fixed costs remain more or less constant regardless of volume and include items such as lease expense, advertising and marketing, insurance, corporate overhead, and administrative salaries. Ratings are assessed on the issuer corporate credit ratings as well as on the individual 48 debt instruments facility ratings.
If available, quarterly estimates should be used as the basis for calendarizing financial 49 projections. The marginal tax rate for U. The highest federal corporate income tax rate for U. Most public companies disclose their federal, state, and local tax rates in their Ks in the notes to their financial statements.
When a company seeks to register securities with the SEC, it must file a registration statement. Within the registration statement is a preliminary prospectus. Once the registration statement is deemed effective, the company files the final prospectus as a includes final pricing and other key terms.
As previously discussed, however, the banker needs to confirm beforehand that the 52 estimates have been updated for the announced deal prior to usage. For illustrative purposes, we assume that the number of fully diluted shares 55 outstanding remains constant for each of the equity values presented.
As discussed in Chapter 3: Discounted Cash Flow Analysis, however, assuming the existence of stock options, the number of fully diluted shares outstanding as determined by the TSM is dependent on share price, which in turn is dependent on equity value and shares outstanding see Exhibit 3. This process incorporates a similar approach to that for determining a universe of comparable companies.
The best comparable acquisitions typically involve companies similar to the target on a fundamental level i. As with trading comps, it is often challenging to obtain a robust universe of truly comparable acquisitions. This exercise may demand some creativity and perseverance on the part of the banker.
For example, it is not uncommon to consider transactions involving companies in different, but related, sectors that may share similar end markets, distribution channels, or financial profiles. Under normal market conditions, transaction comps tend to provide a higher multiple range than trading comps for two principal reasons. Second, strategic buyers often have the opportunity to realize synergies, which supports the ability to pay higher purchase prices.
Synergies refer to the expected cost savings, growth opportunities, and other financial benefits that occur as a result of the combination of two businesses. Potential acquirers look closely at the multiples that have been paid for comparable acquisitions. As in Chapter 1, this chapter employs a step-by-step approach to performing precedent transactions, as shown in Exhibit 2. Select the Universe of Comparable Acquisitions. The identification of a universe of comparable acquisitions is the first step in performing transaction comps.
This exercise, like determining a universe of comparable companies for trading comps, can often be challenging and requires a strong understanding of the target and its sector. As a starting point, the banker typically consults with peers or senior colleagues to see if a relevant set of comparable acquisitions already exists internally.
Equity and fixed income research reports for the target if public , its comparable companies, and overall sector may also provide lists of comparable acquisitions, including relevant financial data for reference purposes only. As part of this process, the banker seeks to learn as much as possible regarding the specific circumstances and deal dynamics of each transaction.
Locating information on comparable acquisitions is invariably easier for transactions involving public companies including private companies with publicly registered debt securities due to SEC disclosure requirements. For competitive reasons, however, public acquirers sometimes safeguard these details and only disclose information that is required by law or regulation. Once the relevant deal-related and financial information has been located, the banker is prepared to spread each selected transaction.
This involves entering the key transaction data relating to purchase price, form of consideration, and target financial statistics into an input page, where the relevant multiples for each transaction are calculated. The key multiples used for precedent transactions mirror those used for comparable companies e. As with comparable companies, certain sectors may also rely on additional or other metrics to derive valuation see Chapter 1, Exhibit 1.
The notable difference is that multiples for precedent transactions often reflect a premium paid by the acquirer for control and potential synergies. In addition, multiples for precedent transactions are typically calculated on the basis of actual LTM financial statistics available at the time of deal announcement.
Benchmark the Comparable Acquisitions. As with trading comps, the next level of analysis involves an in-depth study of the selected comparable acquisitions so as to identify those most relevant for valuing the target.
As part of this benchmarking analysis, the banker examines the key financial statistics and ratios for the acquired companies, with an eye toward those most comparable to the target. Output pages, such as those shown in Exhibits 1. Other relevant deal circumstances and dynamics are also examined. The transaction multiples for each selected acquisition are linked to an output sheet where they can be easily benchmarked against one another and the broader universe see Exhibit 2.
Each precedent transaction is closely examined as part of the final refining of the universe, with the best comparable transactions identified and obvious outliers eliminated. Ultimately, an experienced sector banker is consulted to help determine the final universe. In precedent transactions, the multiples of the selected comparable acquisitions universe are used to derive an implied valuation range for the target.
The banker typically uses the mean and median multiples from the universe as a guide to establish a preliminary valuation range for the target, with the high and low ends also serving as reference points. These calculations often serve as the precursor for a deeper level of analysis whereby the banker uses the multiples from the most relevant transactions to anchor the ultimate valuation range.
Often, the banker focuses on as few as two or three of the most similar transactions. When practical, the banker consults with peers or senior colleagues with first-hand knowledge of relevant transactions. Senior bankers can be helpful in establishing the basic landscape by identifying the key transactions in a given sector. Screen for Comparable Acquisitions The initial goal when screening for comparable acquisitions is to locate as many potential transactions as possible for a relevant, recent time period and then further refine the universe.
Below are several suggestions for creating an initial list of comparable acquisitions. This next level of analysis involves examining factors such as market conditions and deal dynamics. Market Conditions Market conditions refer to the business and economic environment, as well as the prevailing state of the capital markets, at the time of a given transaction.
They must be viewed within the context of specific sectors and cycles e. These conditions directly affect availability and cost of acquisition financing and, therefore, influence the price an acquirer is willing, or able, to pay. They also affect buyer and seller confidence with respect to undertaking a transaction. For example, at the height of the technology bubble in the late s and early s, many technology and telecommunications companies were acquired at unprecedented multiples.
Equity financing was prevalent during this period as companies used their stock, which was valued at record levels, as acquisition currency. The multiples paid for companies during this period quickly became irrelevant for assessing value in the following era.
In the ensuing credit crunch that began during the second half of , however, debt financing became scarce and expensive, thereby dramatically changing value perceptions. Deal Dynamics Deal dynamics refer to the specific circumstances surrounding a given transaction. For example: Was the acquirer a strategic buyer or a financial sponsor? Was the target sold through an auction process or negotiated sale? Was the nature of the deal friendly or hostile?
What was the purchase consideration i. This information can provide insight into factors that may have impacted the price paid by the acquirer. Strategic Buyer vs. Financial Sponsor Traditionally, strategic buyers have been able to pay higher purchase prices than financial sponsors due to their potential ability to realize synergies from the transaction, among other factors, including lower cost of capital and return thresholds.
During periods of robust credit markets, such as the mids, however, sponsors were able to place higher leverage on targets and, therefore, compete more effectively with strategic buyers on purchase price. In the ensuing credit crunch, the advantage shifted back to strategic buyers as only the strongest and most creditworthy companies were able to source acquisition financing.
Motivations Buyer and seller motivations may also play an important role in interpreting purchase price. Similarly, a financial sponsor may be more aggressive on price if synergies can be realized by combining the target with an existing portfolio company. A corporation in need of cash that is selling a non-core business, for example, may prioritize speed of execution, certainty of completion, and other structural considerations, which may result in a lower valuation than a pure value maximization strategy.
Sale Process and Nature of the Deal The type of sale process and nature of the deal should also be examined. For example, auctions, whereby the target is shopped to multiple prospective buyers, are designed to maximize competitive dynamics with the goal of producing the best offer at the highest possible price.
Hostile situations, whereby the target actively seeks alternatives to a proposed takeover by a particular buyer, may also produce higher purchase prices. A merger of equals MOE transaction, on the other hand, is premised on partnership with the target, thereby foregoing a typical takeover premium as both sides collectively participate in the upside e.
Purchase Consideration The use of stock as a meaningful portion of the purchase consideration tends to result in a lower valuation measured by multiples and premiums paid than for an all-cash transaction. The primary explanation for this occurrence is that when target shareholders receive stock, they retain an equity interest in the combined entity and, therefore, expect to share in the upside driven by growth and realizing synergies.
Target shareholders also maintain the opportunity to obtain a control premium at a later date through a future sale of the company. As a result, target shareholders may require less upfront compensation than for an all-cash transaction in which they are unable to participate in value creation opportunities that result from combining the two companies.
Locating information on comparable acquisitions is invariably easier for transactions involving public targets including private companies with publicly registered debt securities due to SEC disclosure requirements. In many cases, it is often challenging and sometimes impossible to obtain complete or any financial information necessary to determine the transaction multiples in such deals.
For competitive reasons, even public acquirers may safeguard these details and only disclose information that is required by law or regulation. Nonetheless, the resourceful banker conducts searches for information on private transactions via news runs and various databases. In some cases, these searches yield enough data to determine purchase price and key target financial statistics; in other cases, there simply may not be enough relevant information available. Below, we grouped the primary sources for locating the necessary deal-related and financial information for spreading comparable acquisitions into separate categories for public and private targets.
Public Targets Proxy Statement In a one-step merger transaction,1 the target obtains approval from its shareholders through a vote at a shareholder meeting. Prior to the vote, the target provides appropriate disclosure to the shareholders via a proxy statement.
As such, it is a primary source for locating key information used to spread a precedent transaction. In addition, a registration statement to register the offer and sale of shares must be filed with the SEC if no exemption from the registration requirements is available. In response to the tender offer, the target files a Schedule 14D-9 within ten business days of commencement. The Schedule TO and the Schedule 14D-9 include the same type of information with respect to the terms of the transaction as set forth in a proxy statement.
It may also contain acquirer and target financial information, including on a pro forma basis to reflect the consummation of the transaction if applicable, depending on the materiality of the transaction. In the event a public company is selling a subsidiary or division that is significant in size, the parent company typically files an 8-K upon announcement of the transaction.
Public acquirers are also required to file an 8-K upon announcement of material transactions. The press release filed upon announcement typically contains a summary of the deal terms, transaction rationale, and a description of the target and acquirer. This is a relatively common occurrence in competitive situations where two or more parties enter into a bidding war for a target.
In some cases, the banker may use a filing after announcement if the financial information is deemed more relevant. Furthermore, research reports typically provide color on deal dynamics and other circumstances. Private Targets A private target i. As previously discussed, regardless of the type of financing, the acquirer files an 8-K upon announcement and completion of material transactions. For LBOs of private targets, the availability of necessary information depends on whether public debt securities typically high yield bonds are issued as part of the financing.
In this case, the S-4 contains the relevant data on purchase price and target financials to spread the precedent transaction. In these situations, the banker must rely on less formal sources for deal information, such as press releases and news articles. The banker should also search relevant sector- specific trade journals for potential disclosures. Any information provided on these all- private transactions, however, relies on discretionary disclosure by the parties involved.
As a result, in many cases it is impossible to obtain even basic deal information that can be relied upon, thus precluding these transactions from being used to derive valuation. In general, if applicable, the definitive proxy statement or tender offer document should serve as the primary source for deal-related data. Exhibit 2. This involves entering the key transaction data relating to purchase price, form of consideration, and target financial statistics into an input page, such as that shown in Exhibit 2.
An input sheet is created for each comparable acquisition, which, in turn, feeds into summary output sheets used for the benchmarking analysis. In the pages that follow, we explain the financial data displayed on the input page and the calculations behind them. Our focus for this section, therefore, is on certain nuances for calculating equity value and enterprise value in precedent transactions, including under different purchase consideration scenarios.
We also discuss the analysis of premiums paid and synergies. However, it is based on the announced offer price per share as opposed to the closing share price on a given day. For example, some shareholders may prefer cash over stock as payment due to its guaranteed value.
On the other hand, some shareholders may prefer stock compensation in order to participate in the upside potential of the combined companies. Tax consequences and other issues may also play a decisive role in guiding shareholder preferences. This makes for a simple equity value calculation by multiplying the cash offer price per share by the number of fully diluted shares outstanding. Cash represents the cleanest form of currency and certainty of value for all shareholders. However, receipt of such consideration typically triggers a taxable event as opposed to the exchange or receipt of shares of stock, which, if structured properly, is not taxable until the shares are eventually sold.
As per Exhibit 2. For example, assuming TargetCo has 50 million fully diluted shares outstanding, it will receive 25 million shares of AcquirerCo stock. This structure presents target shareholders with greater certainty in terms of value received as the acquirer assumes the full risk of a decline in its share price assuming no structural protections for the acquirer. In general, a floating exchange ratio is used when the acquirer is significantly larger than the target.
The stock portion of the offer can be set according to either a fixed or floating exchange ratio. The calculation of offer price per share and equity value in a cash and stock transaction assuming a fixed exchange ratio is shown in Exhibit 2.
Multiples for precedent transactions are typically calculated on the basis of actual LTM financial statistics available at the time of announcement. The full projections that an acquirer uses to frame its purchase price decision are generally not public and subject to a confidentiality agreement.
Furthermore, buyers are often hesitant to give sellers full credit for projected financial performance as they assume the risk for realization. The most common enterprise value multiples are shown in Exhibit 2. As discussed in Chapter 1, however, certain sectors may rely on additional or other metrics to drive valuation see Exhibit 1.
As such, it is only relevant for public target companies.
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