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Determine Valuation. The banker typically begins by using the means and medians for the relevant trading multiples e. The high and low multiples for the comparables universe provide further guidance in terms of a potential ceiling or floor. The key to arriving at the tightest, most appropriate range, however, is to rely upon the multiples of the closest comparables as guideposts. Consequently, only a few carefully selected companies may serve as the ultimate basis for valuation, with the broader group serving as additional reference points.
The chosen range is then applied to the target's relevant financial statistics to produce an implied valuation range. The analysis uses an algorithmic approach to identify comparable companies and calculate metrics, and can be customized to reflect a banker's judgment regarding specific calculations and company peers. STEP I. In order to identify companies with similar business and financial characteristics, it is first necessary to gain a sound understanding of the target.
At its base, the methodology for determining comparable companies is relatively intuitive. For a target with no clear, publicly traded comparables, the banker seeks companies outside the target's core sector that share business and financial characteristics on some fundamental level. For example, a medium-sized manufacturer of residential windows may have limited or no truly direct publicly traded peers in terms of products, namely companies that produce windows.
If the universe is expanded to include companies that manufacture building products, serve homebuilders, or have exposure to the housing cycle, however, the probability of locating companies with similar business drivers is increased. In this case, the list of potential comparables could be expanded to include manufacturers of related building products such as decking, roofing, siding, doors, and cabinets.
Toward this end, the banker is encouraged to read and study as much company- and sector-specific material as possible. The actual selection of comparable companies should only begin once this research is completed. Private companies present a greater challenge as the banker is forced to rely upon sources such as corporate websites, sector research reports, news runs, and trade journals for basic company data.
Public competitors' SEC filings, research reports, and investor presentations may also serve as helpful sources of information on private companies. Identify Key Characteristics of the Target for Comparison Purposes A simple framework for studying the target and selecting comparable companies is shown in Exhibit 1. This framework, while by no means exhaustive, is designed to determine commonality with other companies by profiling and comparing key business and financial characteristics.
Relevant Bloomberg functions for the business and financial framework below are found in Appendix 1. These core traits include sector, products and services, customers and end markets, distribution channels, and geography. Sector Sector refers to the industry or markets in which a company operates e. A company's sector can be further divided into sub-sectors, which facilitates the identification of the target's closest comparables.
Within the industrials sector, for example, there are numerous sub-sectors, such as aerospace and defense, automotive, building products, chemicals, and paper and packaging. 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. A company's sector conveys a great deal about its key drivers, risks, and opportunities.
On the other hand, cyclical or highly fragmented sectors may present growth opportunities that are unavailable to companies in more stable or consolidated sectors. The proper identification and classification of the target's sector and sub-sector is an essential step toward locating comparable companies.
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. Customers and End Markets Customers A company's customers refer to the purchasers of its products and services.
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. While it is generally positive to have low customer concentration from a risk management perspective, it is also beneficial to have a stable customer core to provide visibility and comfort regarding future revenues.
End Markets A company's end markets refer to the broad underlying markets into which it sells its products and services. 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's performance is generally tied to economic and other factors that affect its end markets. 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. 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. 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.
Profitability A company's profitability measures its ability to convert sales into profit. Consequently, determining a company's relative profitability versus its peers' is a core component of the benchmarking analysis see Step IV. Growth Profile A company's growth profile, as determined by its historical and estimated future financial performance, is a critical driver of valuation. 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. In assessing a company's growth profile, historical and estimated future growth rates for various financial statistics e. For early stage or emerging companies with little or no earnings, however, sales or EBITDA growth trends may be more relevant. Return on Investment Return on investment ROI measures a company's ability to provide earnings or returns to its capital providers.
ROI ratios employ a measure of profitability e. Dividend yield, which measures the dividend payment that a company's shareholders receive for each share owned, is another type of return metric. Credit Profile A company's credit profile refers to its creditworthiness as a borrower. 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. In these cases, an examination of the target's public competitors is usually the best place to begin. 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.
For private targets, public competitors' Ks, proxy statements, investor presentations, research reports, and broader industry reports are often helpful sources. 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. 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. Estimates for forward-year financial performance are typically sourced from consensus estimates such as Bloomberg BEst estimates see Appendix 1. LTM financial information is calculated on the basis of data obtained from a company's public filings see Exhibits 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 detailed financial information on a company's final quarter of the fiscal year, the banker refers to the 8-K containing the fourth quarter earnings press release that usually precedes the filing of the K. Proxy Statement A proxy statement is a document that a public company sends to its shareholders prior to a shareholder meeting containing material information regarding matters on which the shareholders are expected to vote.
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. More comprehensive reports provide additional estimated financial information from the research analyst's model, including key items from the income statement, balance sheet, and cash flow statement.
They may also provide helpful sector and market information, as well as explicitly list the research analyst's view on the company's comparables universe. 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.
Therefore, the banker relies upon the financial data provided in the earnings announcement to update trading comps in a timely manner. A company may also release an investor presentation to accompany its quarterly earnings call, which may be helpful in readily identifying key financial data and obtaining additional color and commentary. 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.
A company's press releases and recent news articles are available on its corporate website as well as through Bloomberg. 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 is also a primary source for current and historical company share price information, which is essential for calculating equity value and determining a company's current share price as a percentage of its week high.
Bloomberg Coverage Dashboard summarizes information for investment bankers to monitor and diligence public companies see Appendix 1. Financial information services, such as Bloomberg, may also be sourced to provide information on a company's credit ratings. 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. If a given company's percentage is significantly out of line with that of its peers, it is generally an indicator of company-specific as opposed to sector-specific issues.
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. Calculation of Fully Diluted Shares Outstanding A company's fully diluted shares are calculated by adding the number of shares represented by its in-the-money options, warrants, and convertible securities to its basic shares outstanding. 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.
The incremental shares represented by a company's in-the-money options and warrants are calculated in accordance with the treasury stock method TSM. Options and Warrants—The Treasury Stock Method The TSM assumes that all tranches of in-the-money options and warrants are exercised at their weighted average strike price with the resulting option proceeds used to repurchase outstanding shares of stock at the company's current share price.
In-the-money options and warrants are those that have an exercise price lower than the current market price of the underlying company's stock. As the strike price is lower than the current market price, the number of shares repurchased is less than the additional shares outstanding from exercised options.
This results in a net issuance of shares, which is dilutive. In Exhibit 1. To calculate net new shares, the 4. These new shares are added to the company's basic shares outstanding to derive fully diluted shares of 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.
For the purposes of performing trading comps, to calculate fully diluted shares outstanding, it is standard practice to first determine whether the company's outstanding converts are in-the-money, meaning that the current share price is above the conversion price.
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. Proper treatment of converts requires a careful reading of the relevant footnotes in the company's K or prospectus for the security.
If-Converted Method In accordance with the if-converted method, when performing trading comps, in-the-money converts are converted into additional shares by dividing the convert's amount outstanding by its conversion price. The equity value represented by the convert is calculated by multiplying the new shares outstanding from conversion by the company's current share price. Accordingly, the convert must be excluded from the calculation of the company's total debt.
The new shares from conversion are then added to the company's basic shares outstanding of million and net new shares from in-the-money options of 0. The conversion of in-the-money converts also requires an upward adjustment to the company's net income to account for the foregone interest expense payments associated with the coupon on the convert. 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 shown in Exhibit 1. 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. In both Scenario I and II, enterprise value remains constant despite a change in the company's capital structure. 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. Sales levels and trends are a key factor in determining a company's relative positioning among its peers.
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. 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.
Net income can also be viewed as the earnings available to equity holders once all of the company's obligations have been satisfied e. Wall Street tends to view net income on a per share basis i. It is driven by a company's direct cost per unit, such as materials, manufacturing, and direct labor involved in production.
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. The data that serves as the basis for a company's projected 1-year, 2-year, and long-term45 EPS growth rates is generally obtained from consensus estimates.
The denominator is typically calculated on an average basis e. As a result, ROE incorporates an earnings metric net of interest expense, such as net income, in the numerator and average shareholders' equity in the denominator see Exhibit 1. 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.
Both debt and equity investors closely track a company's leverage as it reveals a great deal about financial policy, risk profile, and capacity for growth. As a general rule, the higher a company's leverage, the higher its risk of financial distress due to the burden associated with greater interest expense and principal repayments.
It is generally calculated on the basis of LTM financial statistics. As EBITDA is typically used as a rough proxy for operating cash flow, this ratio can be viewed as a measure of how many years of a company's cash flows are needed to repay its debt. 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. Therefore, in order to measure financial performance for the most recent annual or LTM period, the company's financial results for the previous four quarters are summed. This financial information is sourced from the company's most recent K and Q, as appropriate.
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. These ratios can also be viewed as a measure of how much investors are willing to pay for a dollar of a company's current or future earnings. 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. The ultimate objective is to determine the target's relative ranking so as to frame valuation accordingly. While the entire universe provides a useful perspective, the banker typically hones in on a selected group of closest comparables as the basis for establishing the target's implied valuation range. 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.
A thoughtful benchmarking analysis goes beyond a quantitative comparison of the comparables' financial metrics. In order to truly assess the target's relative strength, the banker needs to have a strong understanding of each comparable company's story. For example, what are the reasons for the company's high or low growth rates and profit margins? 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?
The ability to interpret these issues, in combination with the above-mentioned financial analysis, is critical to assessing the performance of the comparable companies and determining the target's relative position. 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. As with the financial statistics and ratios, the means, medians, highs, and lows for the range of multiples are calculated and displayed, providing a preliminary reference point for establishing the target's valuation range.
Once the trading multiples have been analyzed, the banker conducts a further refining of the comparables universe. 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.
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 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. Screen for Comparable Companies Our search for comparable companies began by examining ValueCo's public competitors, which we initially identified by perusing the CIM as well as selected industry reports. We then searched through equity research reports on these public competitors for the analysts' views on comparable companies, which provided us with additional companies to evaluate.
These sources provided us with enough information to create a solid initial list of comparable companies see Exhibit 1. We also compiled summary financial information using Bloomberg in order to provide a basic understanding of their financial profiles. 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. Earnings Announcement and Earnings Call Transcript We read through the most recent earnings announcement and earnings call transcript to gain further insight on Gasparro's financial performance and outlook.
Financial Information Service We used Bloomberg to source Gasparro's closing share price on December 20, the day we performed the analysis , as well as its week high and low share price data. Step III. 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. Gasparro's predicted levered beta is 1. 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.
Gasparro's LTM adjusted financial data is also linked to this section and used to calculate trailing trading multiples. FCF is an indicator of a company's ability to return capital to shareholders or repay debt, which accrues to equity holders. For historical data, we used the adjusted income statement financials from Exhibit 1.
The first two benchmarking output pages focused on the comparables' financial characteristics, enabling us to determine ValueCo's relative position among its peers for key value drivers see Exhibits 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. We used the output page in Exhibit 1.
Therefore, we focused on the multiples for ValueCo's closest comparables as the basis for framing valuation. 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. SEC filings can be located online at www. This report often provides a comprehensive business description, sector analysis, and commentary. It also contains forward-looking information about the possible future effects of known and unknown events, conditions, and trends. The K, instead of the Q, is filed after the end of a company's fiscal fourth quarter.
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.
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. 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. Effective for fiscal years beginning after December 15, , FAS changed the accounting and reporting for minority interest, which is now called noncontrolling interest and can be found in the shareholders' equity section of a company's balance sheet.
On the income statement, the noncontrolling interest holder's share of income is subtracted from net income. 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. 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 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. Therefore, the target's fully diluted shares outstanding and implied share price vary in accordance with its amount of stock options and their weighted average exercise price.
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.
In some cases, however, older transactions may be appropriate to evaluate if they occurred during a similar point in the target's business cycle or macroeconomic environment. Under normal market conditions, transaction comps tend to provide a higher multiple range than trading comps for two principal reasons. In return for this premium, the acquirer receives the right to control decisions regarding the target's business and its underlying cash flows. 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. 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.
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.
Once the chosen multiples range is finalized, the endpoints are multiplied by the target's appropriate LTM financial statistics to produce an implied valuation range. As with trading comps, the target's implied valuation range is then given a sanity check and compared to the output from other valuation methodologies. 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. Read more Read less. Special offers and product promotions Amazon Business : For business-exclusive pricing, quantity discounts and downloadable VAT invoices.
Create a free account. Limited-time special offer. Offer valid till 26 November What other items do customers buy after viewing this item? Page 1 of 1 Start over Page 1 of 1. Joshua Rosenbaum. Only 3 left in stock. Investment Banking Workbook: Wiley Finance.
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Rubenstein , Co-Founder and Co-CEO, TheCarlyle Group " Investment Banking provides a highly practical andrelevant guide to the valuation analysis at the core of investmentbanking, private equity, and corporate finance. Lee Capital Management, LLC "The two Joshes present corporate finance in a broad, yetdetailed framework for understanding valuation, balance sheets, andbusiness combinations.
Previously, he worked at the International Finance Corporation, the direct investment division of the World Bank. Joshua Pearl is an investment analyst at Brahman Capital Corp. Previously, he structured and executed leveraged loan and high yield bond financings, as well as leveraged buyouts and restructurings as a Director at UBS Investment Bank in Leveraged Finance.
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Banks also earned revenue by securitizing debt, particularly mortgage debt prior to the financial crisis. Investment banks have become concerned that lenders are securitizing in-house, driving the investment banks to pursue vertical integration by becoming lenders, which is allowed in the United States since the repeal of the Glass—Steagall Act in Mergers and acquisitions and capital markets are also often covered by The Wall Street Journal and Bloomberg.
The financial crisis of — led to the collapse of several notable investment banks, such as the bankruptcy of Lehman Brothers one of the largest investment banks in the world and the hurried sale of Merrill Lynch and the much smaller Bear Stearns to much larger banks, which effectively rescued them from bankruptcy. The entire financial services industry, including numerous investment banks, was rescued by government loans through the Troubled Asset Relief Program TARP.
Surviving U. The crisis led to questioning of the business model of the investment bank  without the regulation imposed on it by Glass—Steagall. After deregulation, those standards were gone, but small investors did not grasp the full impact of the change. A number of former Goldman Sachs top executives, such as Henry Paulson and Ed Liddy were in high-level positions in government and oversaw the controversial taxpayer-funded bank bailout.
The investment banking industry, and many individual investment banks, have come under criticism for a variety of reasons, including perceived conflicts of interest, overly large pay packages, cartel-like or oligopolistic behavior, taking both sides in transactions, and more. Conflicts of interest may arise between different parts of a bank, creating the potential for market manipulation , according to critics. Authorities that regulate investment banking, such as the Financial Conduct Authority FCA in the United Kingdom and the SEC in the United States, require that banks impose a "Chinese wall" to prevent communication between investment banking on one side and equity research and trading on the other.
However, critics say such a barrier does not always exist in practice. Independent advisory firms that exclusively provide corporate finance advice argue that their advice is not conflicted, unlike bulge bracket banks. Conflicts of interest often arise in relation to investment banks' equity research units, which have long been part of the industry. A common practice is for equity analysts to initiate coverage of a company in order to develop relationships that lead to highly profitable investment banking business.
In the s, many equity researchers allegedly traded positive stock ratings for investment banking business. Alternatively, companies may threaten to divert investment banking business to competitors unless their stock was rated favorably. Laws were passed to criminalize such acts, and increased pressure from regulators and a series of lawsuits, settlements, and prosecutions curbed this business to a large extent following the stock market tumble after the dot-com bubble.
Philip Augar , author of The Greed Merchants , said in an interview that, "You cannot simultaneously serve the interest of issuer clients and investing clients. Many investment banks also own retail brokerages. During the s, some retail brokerages sold consumers securities which did not meet their stated risk profile. This behavior may have led to investment banking business or even sales of surplus shares during a public offering to keep public perception of the stock favorable.
Since investment banks engage heavily in trading for their own account, there is always the temptation for them to engage in some form of front running — the illegal practice whereby a broker executes orders for their own account before filling orders previously submitted by their customers, thereby benefiting from any changes in prices induced by those orders.
Documents under seal in a decade-long lawsuit concerning eToys. Depositions in the lawsuit alleged that clients willingly complied with these demands because they understood it was necessary in order to participate in future hot issues. Investment banking is often criticized for the enormous pay packages awarded to those who work in the industry. Such pay arrangements have attracted the ire of Democrats and Republicans in the United States Congress , who demanded limits on executive pay in when the U.
Writing in the Global Association of Risk Professionals journal, Aaron Brown, a vice president at Morgan Stanley, says "By any standard of human fairness, of course, investment bankers make obscene amounts of money. From Wikipedia, the free encyclopedia. Type of private company. Types of banks. Funds transfer. Automated teller machine Bank regulation Loan Mobile banking Money creation Bank secrecy Ethical banking Fractional-reserve banking Full-reserve banking Islamic banking Private banking.
Related topics. See also: History of investment banking in the United States. Global market share of revenue of leading investment  institutions percentage JPMorgan. See also: List of corporate collapses and scandals. Retrieved 5 August Law and Corporate Finance. Edward Elgar Publishing Ltd.
First Things. Retrieved 21 November Goldman noted, 'Western societies developed the institutions that support entrepreneurship only through a long and fitful process of trial and error. Stock and commodity exchanges, investment banks , mutual funds , deposit banking, securitization, and other markets have their roots in the Dutch innovations of the seventeenth century but reached maturity, in many cases, only during the past quarter of a century.
Civil Service College Singapore. Harvard Business Law Review. Journal of Business and Technology Law : 75— Journal of Applied Corporate Finance. Retrieved 29 January The Financial Times. Retrieved 23 October Archived from the original on 7 July Retrieved 23 February Archived from the original on 14 February Archived from the original on 1 August Retrieved 16 September Dream turns to nightmare.
The Economist. City of New York. Retrieved 8 December Retrieved 1 April In fact, the financial crisis might not have happened at all but for the repeal of the Glass—Steagall law that separated commercial and investment banking for seven decades. The Wall Street Journal. Retrieved 4 July Wall Street Journal.
The Times. Retrieved 7 March Global Association of Risk Professionals New York Times. Retrieved 14 March Corporate finance and investment banking. Debt restructuring Debtor-in-possession financing Financial sponsor Leveraged buyout Leveraged recapitalization High-yield debt Private equity Project finance.
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Morgan Stanley. Bank of America Merrill Lynch. Product not available for purchase. Perella Foreword by. 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.
In the aftermath of the subprime mortgage crisis and ensuing credit crunch, the world of finance is returning to the fundamentals of valuation and critical due diligence. This involves the use of more realistic assumptions governing approach to risk as well as a wide range of value drivers.
In this sense, this book is particularly topical—in addition to detailing the technical fundamentals behind valuation, the authors infuse practical judgment skills and perspective to help guide the science. View Instructor Companion Site. Contact your Rep for all inquiries. He originates, structures, and executes leveraged loan and high yield bond financings, as well as leveraged buyouts, and restructurings.
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