Lecture 6 - Valuation: Precedent Transaction Analysis

Step 1 of this is the same as comparable analysis, what is the first step and what is done first?

Step 1 - Select the Universe of Comparable Companies

Screen for Comparable Acquisitions:

• Screen transactions by industry, size, consideration, time period, geography, etc

• Review the target’s M&A history and the multiples it paid/received in past deals

• Revisit comparable companies and examine their M&A history

• Search merger proxies, which often list comparable transactions from fairness opinions

• Review equity and fixed income research reports for the target, peers, and sector for additional comparable deal references

What other considerations are made here about selecting comparable companies?

• Market Conditions: The business and economic environment, as well as the prevailing state of the capital markets at the time of a given transaction

• Deal dynamics

  • Was the acquirer a strategic buyer or a financial sponsor?

  • What were the buyer’s and seller’s motivations for the transactions?

  • Was the target sold through an auction process or a negotiated sale? Was the nature of the deal friendly or hostile?

  • What was the purchase consideration?

What is a strategic buyer and a financial sponsor?

• A strategic buyer is an operating company acquiring another company in a related industry to expand its business. Goal: Long-term strategic benefits such as synergies, market share, products, technology or customers. Can often pay more because it expects synergies, cost savings or revenue growth

• A financial sponsor (ie. PE buyer) is an investment firm that acquires companies to generate financial returns, usually by improving performance and selling later. Goal: Return on investment, not strategic integration. Often uses leverage to fund deals

Describe auctions

• The seller markets the company to multiple potential buyers at the same time

• Goal: Create competition so that buyers bid against each other

• Usually leads to higher purchase prices and better terms for the seller

Describe a hostile takeover

• A buyer tries to acquire the target company without the approval of the target’s management or board

• The buyer may go directly to shareholders or try to replace the board

• Because the target resists, the buyer often has to offer a higher price to convince shareholders

Describe a merger of equals

• Two companies of similar size and strength combine as partners rather than one buying the other

• There is usually no takeover premium

• Both companies’ shareholders share future growth and synergies

What are the purchase consideration options?

• All cash transactions

• Stock transactions

• Cash and stock transactionS

The use of stock as a meaningful portion of the purchase consideration tends to result in a lower valuation than for an all-cash transaction. Discuss why?

When stock is used as part of the purchase consideration, the seller retains shares in the combined business and can share in its future upside. This reduces the certainty of the value received compared with an all-cash transaction, where the seller receives a fixed amount of cash immediately. Therefore, the seller may accept a lower valuation in exchange for the potential to benefit from future growth

How is the necessary deal-related and financial information located?

How is the information obtained for a private company rather than a public company?

For the next step, spreading key statistics, ratio and trading multiples, how is equity value in precedent transactions calculated?

• Based on the offer price per share, not the market closing price

• Equity Value = Offer price x Fully dilutes shares outstanding

• Fully diluted shares include:

  • All in-the-money options/warrants

  • Convert in-the-money convertibles/equity-linked

• Private targets: Equity Value = Enterprise Value - Net debt

Again describe the purchase consideration about equity value

• Mix of cash, stock or other securities offered to target shareholders

• Form of payment influences perceived value, risk and tax impact

• Shareholder preferences:

  • Cash = certainty of value

  • Stock = upside potential in combined company

  • Cash payments may trigger an immediate tax liability, whereas receiving shares may allow shareholders to defer tax. This can influence which offer shareholders prefer

• Primary forms:

  • All-cash

  • Stock-for-stock

  • Cash/stock mix

• Fully diluted share count must be calculated at the price used to value the acquisition (offer price for the target)

Describe the all-cash transaction with an example

• Acquirer buys shares entirely with cash

• Equity value = offer price x fully diluted shares

• Most certain, but usually taxable immediately

• Stock consideration can be tax-deferred if structured properly

Describe the stock-for-stock transaction

• The buyer doesn’t pay cash, but instead gives its own shares to the target’s shareholders

• To decide how many shares the target receives, there are two main methods - fixed exchange ratio (most common) and floating exchange ratio

Describe the fixed exchange ratio with a diagram

• The number of buyer shares per target share is fixed upfront and doesn’t change, eg. For every 1 share of target, the acquirer gives 0.5 of their shares (exchange ratio is 0.5)

• The value of what the target receives goes up or down with the acquirer’s stock price. The number of shares the target receives is fixed

How is offer price per share and equity value of target calculated using the fixed exchange ratio?

Describe the floating exchange ratio using a diagram

• The value paid per target share is fixed in dollars, but the number of buyer shares changes depending on the buyer’s stock price, eg. Target shareholders will get $20 of the acquirer’s stock per share. If acquirer’s stock = $10, they will get 2 shares, if its $5 they’ll get 4 shares

• The number of shares adjusts and the value is fixed

• Equity value = the value paid per target share x target’s fully diluted shares outstanding

Describe the cash and stock transaction and how offer price per share and equity value of target are calculated (assuming a fixed exchange ratio)

• A combination of cash and stock as the purchase consideration

• Cash portion: Fixed value per share to the target’s shareholders

• Stock portion: A fixed or floating exchange ratio

How is enterprise value (aka transaction value) calculated?