Valuation Basics

• Comparable Companies,

• Precedent Transactions

• Discounted Cash Flow Analysis.

1. There is no fixed ranking of valuation methods

2. Precedent Transactions usually show higher values than Comparable Companies → Due to the control premium in acquisitions

3. DCF is highly assumption-dependent → Can produce the highest or lowest value → More variable than other methods

1. Don’t use a DCF when:

   • The company has unstable or unpredictable cash flows (e.g. tech or biotech startups)

   • Debt and working capital function differently than normal → Example: banks and financial institutions

2. Reason:

   • Banks don’t reinvest debt like other companies

   • Working capital is a core part of their business model, not just a cash flow item

• Liquidation Valuation:

  • Value = assets sold off – liabilities

  • Shows what equity holders would get if the company shut down

• Replacement Value:

  • Value based on the cost to replace the company’s assets

• LBO Analysis:

  • Estimates how much a PE firm could pay to reach a target IRR (typically 20–25%)

• Sum of the Parts:

  • Value each business unit separately, then add them up

• M&A Premiums Analysis:

  • Look at past deals to see how much buyers paid above market price

• Future Share Price Analysis:

  • Project future share price using P/E multiples, then discount to present value

• Liquidation Valuation is most common in bankruptcy situations

• Used to see if equity holders get anything after debts are paid

• Helps decide whether to sell assets separately or sell the whole company

• Often used to advise distressed businesses

1. Used when a company has very different divisions (e.g. a conglomerate)

2. Example: General Electric with plastics, energy, finance, tech, etc.

3. You can’t use the same comparables for all divisions

4. Instead, value each division separately using relevant comps

5. Then add them up to get the total (combined) value

1. Used when analyzing a Leveraged Buyout (LBO)

2. Also helps estimate what a private equity firm could afford to pay

3. PE firms usually pay less than strategic buyers

4. Often used to set a valuation floor in deal scenarios

1. EV/Revenue – Enterprise Value to Revenue

2. EV/EBITDA – Enterprise Value to EBITDA

3. EV/EBIT – Enterprise Value to EBIT

4. P/E – Share Price divided by Earnings per Share

5. P/BV – Share Price divided by Book Value per Share

Technology (Internet)

• EV / Unique Visitors, EV / Pageviews

• Focuses on traffic as the main value driver, not revenue or profit

Retail / Airlines

• EV / EBITDAR (adds back Rent)

• Some firms own vs. rent property → EBITDAR normalizes this difference

Energy

• EV / EBITDAX (adds back Exploration Expense) → Normalizes differences in accounting treatment of exploration costs

• EV / Daily Production, EV / Proved Reserves → Value is based on oil & gas reserves, not earnings

REITs (Real Estate Investment Trusts)

• Price / FFO, Price / AFFO → FFO = Adds back Depreciation, subtracts property sale gains → Used because Depreciation is large and non-cash, and sales gains are non-recurring

• Use Enterprise Value when the metric (e.g. scientists, subscribers) benefits all investors (debt + equity)

• Only use Equity Value when the metric is only available to equity holders

• Always ask: “Who has access to the value this metric represents?” → Match the denominator (EV or Equity) to the audience of the metric

• LBO valuation is usually lower than a DCF

• In an LBO, value comes mostly from the terminal value (Year 1 to exit year cash flows are ignored)

• In a DCF, value includes both intermediate cash flows and terminal value

• LBO doesn’t produce a valuation directly → You set a target IRR, then back into the maximum price you can pay

1. Use a “football field” chart to show valuation ranges from different methods

2. Always show a range, not a single number

3. Each methodology (e.g., DCF, Comps, Precedents, LBO) gives its own valuation range

4. This helps visualize high/low estimates and compare methods

5. Example: See Credit Suisse’s 2005 valuation of Sungard Data Systems (pg. 10 in linked document)

• You value an apple tree the same way you value a company:

  • Relative valuation: Compare it to similar apple trees

  • Intrinsic valuation: Estimate the cash flows (value of apples it produces)

1. EBITDA represents earnings before interest, so it’s available to all investors (debt + equity)

2. Enterprise Value also reflects value for all investors

3. Therefore, it’s logical to pair EV with EBITDA in valuation multiples (e.g., EV/EBITDA)

• Unusual case: Liquidation Valuation gives a higher value than other methods

• Can happen if:

  • Company has valuable hard assets

  • Market is severely undervaluing it (e.g., due to bad earnings or cyclicality)

• Comps and Precedents may also be low in this case

• Liquidation Value might be more accurate if assets are worth more than the market thinks

1. For unprofitable or early-stage companies (e.g. tech startups):

   • Use Comparable Companies and Precedent Transactions

   • Focus on creative multiples:

     • EV/Unique Visitors, EV/Pageviews

   • Don’t use a DCF if you can’t predict cash flows

2. Common mistake: Trying to force a DCF on a company with no profits or visibility

• Unlevered Free Cash Flow (UFCF):

  • Excludes interest → available to all investors

  • Use Enterprise Value

• Levered Free Cash Flow (LFCF):

  • Includes interest and debt repayments

  • Only available to equity investors

  • Use Equity Value

• Key logic: Match the cash flow to the investor group it applies to

• Negative Enterprise Value can happen with large financial institutions that have huge cash balances

• In such rare cases, you might use Equity Value / Revenue instead of EV/Revenue

• This may be done to match presentation format (e.g. on a slide with mixed company types)

• Typically for banks, you'd still rely on P/E and P/BV multiples

• Revenue-based EV multiples are rarely used for financial institutions

3 Main Screening Criteria

1. Industry classification (most important – always used)

2. Financial criteria (e.g. Revenue, EBITDA, Market Cap)

3. Geography (e.g. U.S., Europe, Asia)

Additional Filters for Precedent Transactions

• Filter by deal date – usually look at the last 1–2 years

Examples

• Comparable Companies:

  • Oil & gas producers with market caps over $5B

  • Digital media companies with revenue over $100M

• Precedent Transactions:

  • Airline M&A deals in past 2 years, sellers with $1B+ revenue

  • Retail M&A deals in past year

1. Core method:

   • Take the median multiple from your comparables or transactions

   • Multiply it by the company’s own metric (e.g. EBITDA, Revenue)

2. Example:

   • Median EBITDA multiple = 8x

   • Company EBITDA = $500M

   • Implied Enterprise Value = $4B

3. For a football field chart:

   • Use min, max, 25th, and 75th percentiles

   • This shows a valuation range from each method

• Used in pitch books and client presentations to show valuation expectations

• Used in Fairness Opinions before a deal closes

  • Confirms the price is “fair” from a financial perspective

• Applied in:

  • Defense analyses

  • Merger models

  • LBO models

  • DCF models (for terminal value via multiples)

• In short: valuation is used in almost every major finance context

1. Strong recent earnings → stock price has jumped

2. Owns unique IP or patents not fully reflected in the financials

3. Favorable legal outcome (e.g., won a major lawsuit)

4. Is a market leader with significantly higher market share than competitors

• No company is ever 100% comparable to another

• The market is emotional – multiples can swing based on short-term sentiment

• Small or illiquid stocks may trade below their true value due to low trading volume

1. Use the 75th percentile or higher of the comps instead of the median

2. Add a premium to certain multiples (e.g. for strategic value or growth)

3. Use more aggressive financial projections for the company

4. In practice, you rarely use all of these at once – just options to consider

• No strict rule, but you usually use the median (middle range)

• Use the 25th percentile or lower if the company is underperforming or distressed

• Use the 75th percentile or higher if the company is outperforming or has an advantage

• Adjust based on how the company compares to peers

1. Occurs when there’s a mismatch between M&A and public markets

2. Example: No recent public company deals, but many small private acquisitions at low valuations

3. This can skew precedent transaction multiples lower than expected

4. In finance, most general rules have exceptions — context always matters

1. Past deals are rarely 100% comparable

   • Differences in deal structure, company size, and market sentiment affect valuation

2. Data is harder to find, especially for small private company acquisitions

3. Results can be less consistent or reliable than public comparables

1. One deal was more competitive, with multiple bidders driving up the price

2. One target had bad news or a low stock price, leading to a discounted acquisition

3. The companies were in different industries with different typical multiples

• EBITDA ignores Capital Expenditures, which are real cash outflows

• Buffett's quote: “Does management think the tooth fairy pays for CapEx?”

• EBITDA can overstate profitability by leaving out key spending

• In capital-intensive industries, the gap between EBIT and EBITDA can be very large → Makes EBITDA less useful for true cash flow analysis

1. P/E (Price / Earnings)

   • Depends on capital structure

   • Use for banks, financial institutions, or companies where interest expense matters

2. EV / EBIT

   • Includes Depreciation & Amortization

   • Use in capital-intensive industries (e.g. manufacturing) where CapEx and fixed assets are significant

3. EV / EBITDA

   • Excludes Depreciation & Amortization

   • Use in industries with low CapEx and minimal fixed assets (e.g. Internet or software companies)

   • Capital structure-neutral

1. Enterprise Value stays the same in both cases

2. Leased machines:

   • Lease expense shows up in SG&A → reduces EBITDA

   • Result: EV/EBITDA is higher

3. Owned (depreciated) machines:

   • Depreciation is below EBITDA → EBITDA is higher

   • Result: EV/EBITDA is lower

4. So: You’d pay more for the company that leases, because its EBITDA is lower, making the multiple appear higher

• Use the same core methods:

  • Public comps, Precedent Transactions, and DCF

Key Differences:

• Apply a discount (10–15%) to public multiples due to lack of liquidity

• No premiums analysis or future share price analysis → Private companies don’t have a share price

• Result is an Enterprise Value, not a per-share price

• DCF is trickier:

  • No market cap or Beta

  • Use estimated WACC based on public comps

1. No discount for Precedent Transactions:

   • You’re buying the entire company, and the shares become illiquid post-acquisition anyway

2. Discount applies to Public Company Comparables:

   • Public shares are liquid, but private company shares are not

   • To reflect the liquidity gap, apply a 10–15% discount to public multiples

• Use private companies only in Precedent Transactions analysis

• Don’t include them in:

  • Public company comparables (they’re not public)

  • Cost of Equity or WACC in a DCF (no market cap or Beta available)

• Reason: Private companies lack market data, so they can't be used in market-based models