By Victor Paquet (Mergersight Operations) and Carlo Lepoardi & Tommaso Arona (Boston University partners)
Walkthrough
Precedent Transactions Analysis, just like the Comparable Companies Analysis (covered in an earlier post) employs a multiples-based approach to derive a valuation range for a given target company or asset. As the name suggests, it is premised on multiples paid for comparable companies in a prior similar M&A transaction.
Hence, the steps are almost identical to the trading comps:
Choose the universe of transactions
Spread key financial metrics: ratios and multiples
Finds the Min & Max, 1st & 3rd quartiles, Median and Average values to derive a valuation range
Step 1 - Choose the Transactions
Just like Companies Comparables Analysis, aim for transactions involving companies with a similar size, industry, geographic area etc… Key metrics should be accessible through public filings ( e.g. SEC fillings, Yahoo Finance, Capital IQ, Bloomberg). A further aspect to look for is deal dynamics. Was the acquirer a strategic buyer or a financial sponsor? What were the motivations for the transaction? Was the nature of the deal friendly or hostile?
It is important to choose transactions that took place rather recently (in the past 2-3 years maximum) as they more likely took place under similar market conditions. On another hand, it can be interesting to take an older transaction as a comparable if it occurred during a similar point in the target’s business cycle.
Step 2 - Spread Key Stats
Just like the Comps, the two most commonly used trading multiples are EV / EBITDA and P / E, while EV / Revenue is commonly used for private companies.
However, considering this valuation method involves transactions and not just the companies themselves, you need to adjust your multiples by considering nuances applied to the Equity and Enterprise Values.
Equity and Entreprise Values
Equity & Enterprise Values will be calculated in a similar manner compared to Trading comps. However, it will be based on the announced offer price per share and not the closing share price on the market. To that extent, you need to take into account the Premium paid in your Equity Value calculation. The formula is:
(Offer Price per Share / Unaffected Share Price) - 1 = % Premium Paid
i.e: We can for instance calculate a 35% premium assuming that the target’s shareholders were offered £67.5 a share for a stock trading at an unaffected price of £50.
This premium needs to be added to the unaffected share price, increasing the equity value and so the enterprise value overall.
Purchase Considerations
Purchase Considerations refer to the mix of cash, stock and other securities the acquirer offers and how it may affect the target shareholders’ perception of the price offered.
Indeed, some shareholders may prefer cash over stock as payment due to its guaranteed aspect whereas others might prefer stock compensation in order to participate in the upside potential of the combined entity.
Synergies
Synergies refer to the expected cost savings, growth opportunities and other financial benefits that occur as a result of the combination of two businesses. Synergies present tangible value to the acquirer in the form of future cash flows and earnings beyond what can be expected and achieved by the target.
Precedent Transactions’ multiples are typically shown on the basis of the target’s LTM financial information, without taking synergies into account. To that extent, it is common to adjust multiples that reflect expected synergies such as adjusting your EBITDA or EPS values to the denominator.
i.e: EV / LTM EBITDA = £1.2bn / £150m = 8.0x
EV / LTM EBITDA + Synergies = £1.2bn / £150m + £25m = 6.9x
Step 3 - Valuation Range
Just like in a Comps analysis, you have to compute the Minimum and Maximum values, the 1st and 3rd quartiles as well as the Average and Median values.
Note that a common red flag in precedent transactions is when the implied valuation range is lower than the range computed in your comps analysis. In that case, revisit your assumptions and multiples’ calculations in both valuation methods.
N.B: this may not necessarily be a red flag. Indeed, perhaps the company is part of a sector undergoing a cyclical high. As such the valuation range from the comps might be higher than that from precedent transactions.