Trading Multiple Analysis
Comparable company trading multiples analysis or trading comps use the valuation multiples of similar or comparable publicly-traded companies to value a target private company. Peers can be grouped based on any number of criteria, such as industry focus, private company size, or growth. The multiples can be Enterprise Value (EV) based multiples like EV/Sales, EV/EBITDA or EV/EBIT, and Equity-based multiples like Price to Earnings (P/E). The multiples derived from this type of analysis are at a given point in time and generally change over time. It is important to note that trading multiples do not reflect control premiums or potential synergies. Generally, the following steps are applied to compare your target private company to a similar public company:
Compile and select the list of comparable companies — To select the comparable universe or peer group for a given private company target, one must understand the target private company’s business to ensure that its peers share similar industry, business, and financial characteristics with the target. Among the few suitable sources that can provide insight in identifying accurate public comparables are annual reports or 10-K (especially the section on competition), the public companies’ prospectus, SIC code lookup, and PrivCo’s private company reports. Once you have identified the comparable universe, the next step is to gather all necessary information for each peer company, usually from 10-K, 10-Q, and/or 8-K earnings press release, consensus financial projections or a recent analyst research report with financial projections.
Calculate relevant financials and multiples—Making pro forma adjustments to a comparable company’s financial statements is often the trickiest part. It requires normalizing the financials to adjust for one-time / non-recurring items that temporarily distort earnings. Income statement items (denominator) should be adjusted for one-time or non-recurring items. For the valuation purposes, non-recurring items should not be included in financials (e.g. P&L statements, EBIT, EBITDA, Net income, etc.).Create a list of ratios and values which can include price, shares outstanding or market capitalization, earnings per share (EPS), growth rate, price-to-earnings ratio (P/E), price-to-sales ratio (P/S), EV, EBITDA etc. Next step is to calculate multiples. Multiples are the heart of the comparable companies’ analysis as it is hinged on both the comparable company’s risk profile and operating performance. Multiples that are used should be relative to the industry and appropriate in relating the public and private companies.
Equity Multiples—Certain flows apply to equity holders only, like net income and book value of equity. The balance sheet and income statement values utilized are after discretionary debt payments. Hence, equity multiples are used to derive an implied equity value.
Price/Earnings (market equity value / net income to common shareholders)
Price/Book (market equity value / book value of equity)
Price/Cash Flow (market equity value / after-tax cash flow)
PEG Ratio—measures growth prospects (PE Ratio / Annual EPS Growth)
Enterprise multiples—Other flows apply to all capital providers (debt & equity). The balance sheet and income statement values utilized are before the effects of discretionary debt payments. Hence, enterprise multiples are used to derive an implied enterprise value.
Apply valuation and analyze the results—Finally after calculating relevant multiples, one must determine implied valuation ranges. To compare comparable private companies effectively, one must understand why their multiples are different. Reasons why one private company’s projected EV/EBITDA multiple might be lower than that of a peer could include slower projected growth, declining margins, or a higher risk profile. For example, performing a comparable company analysis is an art, not a science. It’s important to pay careful attention to the selection of comps, how one spreads the financial for each private company, and selection of favorable multiples.
Apply a private company discount, if applicable—It is not merely enough to simply use the same multiple as that of another publicly traded company. In most, if not all cases, the multiples that the “comps” universe is trading at must be subjectively adjusted as public companies will typically receive higher valuations than their privately held peers due to a lack of liquidity and the potential restructuring or accounting reorganization challenges that may arise in the event of an exit. Valuation discounts for liquidity should be applied to the private company that best reflects the target private company’s risk and often ranges from 20-30%. A major disadvantage of this valuation method is that it is often difficult to determine the right comparable private companies. Very rarely does one find two identical private companies. Hence, adjustments should be made to reflect differences, such as business mix, geographic spread and capital structure.