A company can be separated into its operating businesses or assets and its non-operating assets. Operating assets are typically the principal sources of a company’s revenues, cash flow, and income. The valuation of operating assets can be done using two different fundamental concepts: a liquidation value and a going concern value. Most of the analysis in investment banking and private equity contemplates valuing a business as a going concern, though liquidation valuation is used occasionally, especially when considering distressed companies.
In the liquidation scenario, which is often used in the context of a distressed sale or a restructuring, each asset or small collection of assets of the company is valued independently. This is done when there is little perceived premium for holding these assets collectively. Examples could include a collection of steel mills that may have value on an individual basis but, due to over-capacity in the industry or regional overlap, may not attract interest from a buyer on a combined basis.
Generally, the most common types of valuation seek to determine a going concern value, in which the company being valued is assumed to continue to operate for the foreseeable future. Note that this is the basis upon which auditors typically give their opinions. In this case, the objective is to value the earnings power and cash generation capability of the collection of assets that make up the operating business, as well as any non-operating or intangible assets or attributes that are owned by the company. Non-operating assets may include interests in other companies, while intangible assets may include trademarks, brands, customer and supplier relationships, technology and know-how, infrastructure and systems, management expertise and experience, etc. In most cases, the going concern value exceeds the liquidation value, because the collection of assets produces a greater return when pooled in an operating business than when separated in a liquidation scenario.
When valuing a company, three techniques are commonly used: comparable company analysis (or "peer group analysis", "equity comps", " trading comps", or "public market multiples"), precedent transaction analysis (or "transaction comps", "deal comps", or "private market multiples"), and discounted cash flow ("DCF") analysis. A fourth type of analysis, a leveraged buyout ("LBO") analysis, is often used to estimate the amount a financial buyer would pay for a company. A fifth type of analysis, a sum-of-the-parts ("SOTP" or "break-up") analysis may be used to value a company as the sum of the values of its composite businesses.
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| Comparable Companies Analysis |
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- Calculates a “fully distributed” trading value
- Estimates a company’s implied value in the public equity markets through an analysis of similar companies’ trading and operating metrics
- Apply multiples derived from similar or "comparable" publicly traded companies to a company’s operating metrics (recognizing that no two companies are exactly alike)
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- Reliability depends on the level of comparability of the selected publicly traded companies
- Does not include a "control premium" (though a change of control premium may be applied to the equity value to estimate a private market value)
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| Precedent Transaction Analysis |
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- Provides a private market benchmark in a change of control scenario
- Apply multiples derived from similar or comparable precedent M&A transactions to a company’s operating metrics
- Includes a control premium
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- Reliability depends on the number of precedent transactions and their levels of comparability
- Market cycles and volatility may affect market historical valuation levels
- Individual buyer synergies and structure of transaction will also impact multiples
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| DCF Analysis |
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- Project the company’s future unlevered cash flows and calculate the present value of those cash flows and the terminal value using an appropriate cost of capital and terminal value methodology
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- This analysis is heavily dependent on cash flow and growth characteristics of the company and the terminal value assumptions
- Appropriate capital structure reflected in valuation analysis through discount rate
- Typically the highest result of the three methods
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| LBO Analysis |
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- Determines the range of prices that a financial buyer would be willing to pay for a company based on target rates of return to equity (IRRs) and a leveraged capital structure
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- This analysis is heavily dependent on the cash flow profile of the asset, its leveragability, and the exit value assumptions
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| Ability-to-Pay (ATP) |
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- Solves for the maximum price that a strategic buyer can pay for the target while holding fixed one or more financial constraints, such as breakeven accretion/dilution in Year 2, IRR > 15%, etc.
- Used to compare the abilities to pay of several potential acquirers, and establish which can pay the highest price
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- This analysis is heavily dependent on the assumed synergies, which vary from acquirer to acquirer and involve a lot of guesswork
- Generally a more useful analysis the more similar potential acquirers’ business models are (e.g. banking sector)
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| SOTP Analysis |
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- Provides a range of values for a company’s equity by summing the values of its individual operating segments to arrive as the total firm value
- Apply multiples derived from comparable publicly traded companies to the operating metrics of each operating unit
- Often used to make a case for the divestiture of one or more businesses
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- Reliability depends on the level of comparability of the selected publicly traded companies
- Does not value synergies of the combined business
- Impossible when financial metrics of operating subsidiaries or divisions are not available
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