IB Manual – Precedent Transaction Analysis
Deriving an implied market valuation for a company in an acquisition context
Precedent Transaction Analysis Guide
Precedent transaction analysis is used to derive an implied market valuation for a company, either public or private, in an acquisition context. Essentially, a precedent transaction analysis looks at previous M&A deals to see how much it cost to acquire a similar business in the past. From past deals, valuation multiples can be derived by dividing the transaction value by the target company’s financials. The valuation multiples are applied to the company being valued in order to give a theoretical value of the business.
This is an excerpt from CFI’s free investment banking manual on how to be an analyst.
Precedent Transaction Analysis – Relevant transactions
Precedent transaction analysis looks at recent acquisitions in a relevant sector. Comparable companies follow similar business activities and, ideally, operate in the same geographical areas. The target companies (both precedent and intended target) should possess similar:
- Business activities
- Geographical location
- Size
- Growth profiles
- Profitability profiles
- Accounting policies
- Public vs. private
For the analysis to be valid, it is especially important that both companies follow the same or very similar accounting policies.
The previous transaction should:
- Show similar acquisition proportions
- Be for similar considerations (cash vs. debt vs. equity)
- Involve similar bidder companies (trading vs. private equity)
- Arise during similar equity market conditions
- Show similar transaction profiles (recommended offer vs. hostile bid vs. contested)
Mechanics of Precedent Transaction Analysis
Summary of precedent transaction analysis information
| Data | Description |
|---|---|
| Date | Announcement and/or closing date of transaction |
| Bidder | Acquirer, including parent company if subsidiary |
| Target | Acquiree, including parent company if subsidiary |
| Target - business description | Description of target’s business activity |
| Local currency | Currency in which the transaction took place |
| Acquired stake | Percentage of the target being acquired (usually 100%) |
| Equity value | Equity consideration to be paid by the bidder |
| Grossed-up equity value | The equity value adjusted when the acquired stake is less than 100%, to reflect the equity value for 100% of the target |
| Net debt acquired | Typically, the net debt of the target. However, special arrangements are possible whereby the acquisition is debt-free or the bidder agrees to take on only part of the target’s debt |
| Implied enterprise value | Grossed-up equity value plus net debt acquired |
Exchange rates for precedent transaction analysis
Use the same currency in both numerator and denominator:
- P&L historic – use average exchange rates for the period
- P&L forecast – use the most recent exchange rate
- B/S – use the exchange rate at the date of the B/S
Deferred payments in precedent transaction analysis
When acquiring a business, a company may defer (pay later) part of the consideration it offers because:
- The management of the target company holds significant stakes in the business, ensuring they continue to work for the company post-acquisition
- The consideration is payable contingent on the acquired company meeting or exceeding projections contained within its business plans
- Tax restructuring reasons
For deferred consideration, ensure that the terms of how it has been created are noted. Include both values and the range of multiples.
Equity value vs. Enterprise value in precedent transaction analysis
The equity and enterprise values are always for 100% of the target company. If the Bidder buys 50% of the Target, the equity and enterprise values are implied from the purchase price. Buying 50% of a company for $10,000,000 implies that the company is worth $20,000,000. If the Bidder buys less than 100%, the amount paid represents a portion of the equity value. Enterprise value is calculated by grossing up the equity value to 100% and adding net debt. However, if the Bidder buys all of the Target, then it also assumes all of the Target’s liabilities. What is described as the “amount paid” might or might not include the debt. It is important to understand what the amount paid represents to avoid calculating incorrect transaction multiples.
Share options and convertible debt
All profitable options are exercisable upon acquisition and should be converted when calculating equity and enterprise value.
Examples of multiples
Private transaction multiples
Valuation multiples can be derived by dividing the transaction value by the target company’s financials.
Public transaction multiples
For private transactions, valuation multiples can be derived by dividing the transaction value by the target company’s financials (or other metrics such as subscribers, square feet, etc.).
For a public company transaction, the premium paid alludes to the fact that a bidder will typically pay a premium above the market valuation to obtain control over the target, This is known as the takeover premium.
Precedent transaction analysis example
Valuing the target
There are numerous ways to select the appropriate transaction multiple from the transaction database:
- Average/median of the transactions
- Average, excluding outliers
- Range around the average
- Identify highest and lowest likely prices.
What method is best depends on:
- Quality of the information going into the precedent transactions database
- Audience
- Situation/environment
The following table provides an example of a precedent transactions analysis:
Checking precedent transaction analysis
- Always check your work.
- Comparable multiples should be checked to see if they are reasonable.
- Footnotes should be used for all assumptions or other points of interest.
Valuation football field
Football fields show the valuation of a company according to different methodologies, as the following examples show:
Control premiums
The takeover premium is the amount in excess of the quoted value of a company that an acquirer pays. It is otherwise known as a “premium for control.”
The ability to control a company has a value:
- Complete control (majority)
- Partial control (minority, significant influence, joint control)
A block of shares providing some level of control may be worth more than the sum of the values of the single shares. Therefore, transaction multiples are higher than the trading multiples of the company. Premiums are more expensive for larger shares of control (the premium for 100% of a company is significantly more than the premium for 5% of a company).
Why pay a premium?
When the equity markets value a company, they are assessing the PV of its future cash flows. The PV of future cash flows is the underlying reason for a takeover.
Synergies
Takeovers are conducted with a premium for the purpose of achieving synergies – how much additional cash the bidder can earn from the target that is not available to:
- The market; or
- The current owner (in a private transaction)
Synergies mean that cash flows discounted by bidders are higher than the cash flows being discounted by the market (or current owner). This, therefore, sets a limit on how much the bidder can pay. If the acquisition is going to add any value to the bidder, then the amount actually paid is generally less than this maximum. Precedent transaction multiples are impacted by the split of the value of synergies between target and bidder.
Drivers of equity return in an LBO
A Leveraged Buyout (LBO) is conducted by using a significant amount of borrowed money to meet the cost of acquisition. In doing so, the LBO team must see significant benefits from paying a premium for the target.
Benefits of leverage
- Tax savings from interest
- Downside limited to equity capital injected
- Potentially high upside for equity holders
Problems with precedent transaction analysis
The process of precedent transaction analysis can face a number of problems, including the following:
- Widely dispersed valuation multiples
- Differing stakes
- Access to information/quality (Private deals)
- Differing reporting standards
- Volatility of public markets
Additional resources
Thank you for reading this section of CFI’s free investment banking book on precedent transaction analysis. To keep learning and advancing your career, the following CFI resources will be helpful:
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