Valuation Methods Used in Corporate Restructuring

Where restructuring is material and involves a transaction, an analyst conducts a preliminary valuation of the target. The analyst can use comparable company analysis, comparable transaction analysis, and premium paid analysis in the target valuation.

Comparable Company Analysis

In comparable company analysis, the analyst determines the target’s value using the valuation multiples of listed companies that are similar to the target. Analysts often use data aggregators such as FactSet, Bloomberg, or Capital IQ to create a set of comparable transactions and companies. Once they have done this, they compute valuation metrics and multiples based on the comparable companies’ current market prices. Enterprise value to the sale and price to earning are common multiples used in this computation. In addition, analysts use sector-specific valuation multiples, e.g., enterprise value, to reserve for oil and gas companies. Enterprise multiples are preferred because they are less sensitive to capital structure differences.

A mean, median, and range will be computed from the multiples, which will either be compared directly with the target’s value or applied to develop an estimated target value. Comparable company analysis is used a lot more in spin-offs than sales or acquisitions because the acquirer pays a premium for control. 

Advantages of Using Comparable Company Analysis

• It provides a sound approximation of a target’s value relative to comparable companies in the market.
• Data is readily available.
• Estimates of value are derived from the market and not based on assumptions such as the discounted cash flow method.

Disadvantages of Using Comparable Company Analysis

• It can be difficult to find a set of listed comparable companies.
• The method is sensitive to market mispricing.
• The method yields an estimated fair trading price for the target.

Comparable Transaction Analysis

Comparable transaction analyses are similar to comparable company analyses, except that an analyst uses valuation multiples from historical acquisitions of similar targets. The valuation multiples in this approach include a takeover premium because they reflect historical sales (acquisitions).

Advantages of Comparable Transactions Analysis

• Value estimates are derived from historical transaction prices for similar targets.
• There is no need to estimate a takeover premium separately.

Disadvantages of Comparable Transaction Analysis

• The corporate control market is illiquid; thus, comparable transactions may be few.
• Historical valuation multiples reflect past macroeconomic conditions as well as historical industry conditions.
• In transactions where multiple companies were competing for a target, there is a risk that the companies were overvalued and acquirers overpaid for the target.

Premium Paid Analysis

To estimate the acquisition price or sales value, an analyst calculates the takeover premium. The takeover premium is the amount shareholders require to relinquish their control of the target to the acquirer. The takeover premium for a historical transaction is calculated as follows:

$$ PRM=\frac{(DP-SP)}{SP} $$

Where:

\(PRM\) = Takeover premium.

\(DP\) = Deal price per share of the target.

\(SP\) = Unaffected stock price of the target.

Any pre-announcement increase in the price that occurred because of rumors and speculation is excluded. A common approach to control this is to use a share price one week before the announcement. An analyst looking to estimate a sale price using the premium paid analysis will compile takeover premiums of companies similar to the target and compute the mean, median, and range similar to the comparable transaction and company analysis.

Question

Which of the following is most likely a benefit that an analyst will enjoy when they use comparable transaction analysis to value a target?

1. The market for corporate control is not liquid.
2. There is no need to estimate a takeover premium separately.
3. Historical valuation multiples reflect past macroeconomic conditions as well as historical industry conditions.

Solution

The correct answer is B. 

When conducting a comparable transaction analysis, it is not necessary to estimate the takeover premium separately since it is part of the transaction.

A and C are incorrect. These are the disadvantages of using comparable transaction analysis.

Reading 21: Corporate Restructuring

LOS 21 (c) Demonstrate valuation methods for, and interpret valuations of, companies involved in corporate restructuring.