Market-Based Valuation

Analysts frequently attempt to calculate the value of private companies by referencing market-based multiples derived from comparable public companies' stock shares. This approach is favored over the income-based valuation method discussed earlier. While, in some instances, these multiples are modified to account for variations in relative risk and growth potential, in other cases, multiple groups of comparable companies are utilized to mirror the diversified business activities of a private firm. We employ this method when conducting a private company valuation using a market-based approach, as outlined below.

Step 1: Choose public comparables and weight to match private company.

Step 2: Gather and summarize multiples from comparable public companies.

EV to EBITDA, EV to EBITA, EV to EBIT, EV to sales, and EV to FCFF.

Step 3: Estimate private company enterprise value from multiples.

$$ \begin{align*} EV_t &=\sum_{w=1}^n w_i \left( \frac {EV_i}{\text{Sales}_i} (\text{Private Company Sales}) \right): \\
w_i & =\frac {\text{Business Line Sales}}{\text{Total Sales}} \end{align*} $$

Step 4: Discount estimated value for illiquidity or minority ownership

Let us now illustrate this using an example.

Example 2: Valuation using the Market Approach

Georgina Dolci has been tasked with analyzing the value of non-controlling minority interest in North Rift Ltd, a private US Company whose shares are not publicly traded. Dolci estimates that the unadjusted value of North Rift is $ 900 million and estimates the control premium at 10%. The company is well-known in the logistics industry but has expanded into the parcel and home delivery markets in recent years. Many of their fleet vehicles in the emerging parcel and home delivery markets are electric to reduce their emissions as a company and comply with industry environmental standards.

$$ \textbf{Exhibit 1: North Rift Ltd Financial Data }\bf{($ \text{ millions}) } \\
\begin{array}{c|c|c|c}
\textbf{Business Line} & \textbf{Revenue} & \textbf{Assets} & \textbf{EBITDA} \\ \hline
\text{Logistic service} & 800 & 1400 & 200 \\ \hline
\text{Parcel} & 160 & 550 & 20 \\ \hline
\text{Home delivery} & 40 & 50 & -10 \\ \hline
\text{Total} & 1000 & 2000 & 210
\end{array} $$

$$ \textbf{Exhibit 2: North Rift Ltd Comparable multiples.} \\
\begin{array}{c|c|c}
\textbf{Business Line} & \textbf{EV/EBITDA} & \textbf{EV/Sales} \\ \hline
\text{Logistic service} & 9.4 & 3.6 \\ \hline
\text{Parcel} & 8.9 & 2.1 \\ \hline
\text{Home delivery} & 21.3 & 7.4
\end{array} $$

To determine the minority interest using the market approach, Dolci will follow these steps:

Step 1: Identify comparable public companies across business lines

$$ \textbf{Exhibit 3: North Rift Ltd Financial Data }\bf {(\% \text{ of total})} \\
\begin{array}{c|c|c|c}
\textbf{Business Line} & \textbf{Revenue} & \textbf{Assets} & \textbf{EBITDA} \\ \hline
\text{Logistic service} & 80\% & 70\% & 95.24\% \\ \hline
\text{Parcel} & 16\% & 27.5\% & 9.52\% \\ \hline
\text{Home delivery} & 4\% & 2.5\% & -4.76\%
\end{array} $$

Step 2: Gather and summarize multiples from comparable public companies.

$$ \textbf{Exhibit 4: North Rift Ltd Comparable multiples.} \\
\begin{array}{c|c|c}
\textbf{Business Line} & \textbf{EV/EBITDA} & \textbf{EV/Sales} \\ \hline
\text{Logistic service} & 9.4 & 3.6 \\ \hline
\text{Parcel} & 8.9 & 2.1 \\ \hline
\text{Home delivery} & 21.3 & 7.4 \\ \hline
\text{Composite} & 8.786 & 3.512
\end{array} $$

$$ \begin{align*}
\text{Composite EV/EBITDA} &=\left(\frac {200}{210} \right) \times 9.4+\left(\frac {20}{210} \right) \times 8.9+\left( \frac {(-10)}{210} \right) \times 21.3 \\ & =8.9524+0.8476-1.0143=8.786 \\
\text{Composite EV/Sales} & =\left( \frac {800}{1000} \right) \times 3.6+ \left( \frac {160}{1000} \right) \times 2.1+\left( \frac {40}{1000} \right) \times 7.4 \\ & =2.88+0.336+0.296=3.512 \end{align*} $$

Step 3: Use multiples to derive an initial value estimate.

Dolci derives preliminary values estimate for North Rift using the following calculation.

$$ EV_{\text{EV/Sales}}=3.512 \times \$1,000,000,000=\$3,512,000,000 $$

Further adjustments are needed because the estimate is based on public company comparables. Dolci needs to multiply North Rift’s revenue by the individual EV/Sales multiples for each business line. The results are as follows:

$$ \textbf{Exhibit 5: North Rift Valuation by Segment Based on EV/Sales} \\
\begin{array}{c|c|c|c}
\textbf{Business line} & \textbf{EV/Sales} & {\textbf{Revenue }} & {\textbf{Stand-alone value }}\\
& & {\bf{(\$ \text{ millions})}} & {\bf{(\$ \text{ million})} } \\
\hline
\text{Logistic services} & 3.6 & 800 & 2,880 \\ \hline
\text{Parcel} & 2.1 & 160 & 336 \\ \hline
\text{Home delivery} & 7.4 & 40 & 296 \\ \hline
\text{Total} & & & 3,512
\end{array} $$

While the total from the segment valuation is the same, each of the three terms may be interpreted as public company value estimates.

$$ EV_{\text{EV/EBITDA}}=8.786 \times \$210,000,000=\$ 1,845,060,000 $$

Step 4: Apply appropriate discounts/premiums to complete the valuation.

From the results derived in step 3, Dolci will need to adjust North Rift's value to reflect a non-marketable and non-controlling shareholders'perspective. For the DLOM, Dolci estimates 15% and 10%, respectively, which will result in a total discount of 25%. Dolci then goes ahead to adjust each of her valuation estimates as follows:

$$ \begin{align*}
EV_{\text{EV/Sales}} & =\$3,512,000,000 \times (1-15\%)=\$2,985,200,000 \\
EV_{\text{EV/EBITDA}} & =\$1,845,060,000 \times (1-10\%) =\$1,660,554,000 \end{align*} $$

By averaging the two market-based results, Dolci may derive a single valuation estimate:

$$ \frac {(\$2,985,200,000+1,660,554,000)}{2}=\$2,322,877,000 $$

Reading 27: Private Company Valuation

LOS 27 (i) Calculate the value of a private company based on market approach methods and describe advantages and disadvantages of each method