Tag: acquisitions

“What’s the value of my company?”

It’s a question that we’re constantly fielding from entrepreneurs operating companies of varying sizes across a broad range of industries. They frequently expect a formula-driven answer, failing to appreciate the breadth of valuation methods, the limitations of each approach, and the judgments required to integrate the various analyses.

Great businesses are built through smarts and hard work, yet some owners shortchange themselves when they are looking to sell their company. They don’t do the last bit of hard work—a multi-faceted valuation—to empower themselves for discussions with potential buyers. It turns out that answering a seemingly simple question can be anything but simple.

As we kick off an initial meeting, many business owners will quickly inform us that they “know their multiple.”  This isn’t surprising. Whether they’re referencing an enterprise value-to-earnings before interest, taxes, depreciation and amortization multiple or an industry-specific multiple (an example being the enterprise value-to-subscriber multiple used in the cable TV industry), owners understand this approach. It’s an easy way to think about valuation that ties in nicely with observable data points at publicly traded companies.

Although comparable public company analysis is appealing due to the abundance of easily obtained information, it is rarely straightforward.

Many years ago, we met with a small regional brewer who likened its business to Anheuser-Busch. Although both companies produced beer, the similarities ended there. Setting aside the drastic difference in business size, Anheuser-Busch was operating a broadly diversified business with snack food, amusement park and aluminum recycling segments beyond its core brewing activities. Applying Anheuser-Busch’s EBITDA multiple to the client company made no sense. Finding truly comparable public brewers and discounting those multiples to account for differing business sizes were key steps in getting to a realistic multiple.

What’s important

Operational comparability and relative business scale remain important when shifting the valuation focus to precedent transaction analysis. Consider a recent example: Is it realistic for a local grocery chain to expect the same multiple that Whole Foods received from Amazon? The business models and scales differ significantly—and so should the multiples. The local grocer needs information on values paid for companies of comparable scope and size to understand his company’s realistic multiple.

As professional advisers, we favor this analysis because it reflects the real world. But, even with specialized databases and proprietary tools, obtaining relevant information can be difficult as the vast majority of company sales are private with limited disclosure about multiples.

If multiple-based analyses depend upon information, what happens when data is scarce or the subject company isn’t generating meaningful earnings? We’ve recently encountered this precise situation at a business that has developed a groundbreaking medical device with worldwide potential. With no comparable companies or transactions and no current earnings, we’re relying on discounted cash flow analysis to value the business — something easier said than done.

The three key ingredients of a DCF valuation are clear-cut: a multiyear cash flow projection, a future estimate of the company’s value and an appropriate discount rate to bring each estimate back to today’s dollars. The pieces of the analysis are well-established. The debates over each piece are equally consistent: Are the projections credible/achievable? Is the future value realistic? Does the discount rate adequately reflect the business risk?

Market observations

Smart, experienced people can differ significantly on each question, and slight variations of opinion can yield dramatically different valuations. With so many subjective moving parts, M&A professionals typically look first to concrete market observations identified with the multiple-based methods. This doesn’t mean that DCF valuation is entirely dismissed with mature, profitable companies. Instead, it is used to complement or confirm the market-based multiples.

For an established company, a completed DCF valuation provides the building blocks for leveraged buyout analysis. Using the financial projections and anticipated exit value from the DCF valuation, LBO analysis examines the interplay of different capital structures and equity return requirements to estimate a valuation range for the business. On the surface, this method can spark the same debates as a DCF analysis but, an active, observable market for capital structures and return expectations enables a trained professional to develop a defensible valuation.

Considering the income statement bias of the foregoing methods, a basic question should be asked: What are the fair market values of the company’s assets? While this approach isn’t likely to drive the overall valuation, it can still have a meaningful impact.

Once we were advising a manufacturer located near London’s Heathrow Airport. The balance sheet recorded the company’s land at its 30-year-old purchase cost, but Heathrow’s expansion had driven skyrocketing land values — a fact overlooked in other valuation methods. In short, a careful balance sheet examination significantly affected the company’s valuation.

In bringing the various valuations together, many business owners expect a level of “agreement” among the different methods. Sometimes, that’s true. In other cases, results can vary widely. The key is properly weighting each method and understanding how they complement each other to arrive at an integrated opinion of value. Of course, the truest test of valuation is the price a third party is willing to pay in a purchase transaction. Even with all of this analysis, the range of bids submitted by various investors can still take us by surprise. The real world is messy, complicated and challenging — why would business valuation be any different?

Stuart Smith and Rob White are managing directors, M&T Investment Banking Group.

(c) 2017 Rochester Business Journal. To obtain permission to reprint this article, call 585-363-7269 or email [email protected].

More companies are finding themselves in the crosshairs of potential buyers as 2017 is on pace to be one of the largest ever for mergers and acquisitions in terms of value.

“It’s a seller’s market right now. There’s not a lot of great acquisitions relatively speaking on the market and so when good opportunities come up, it’s highly competitive,” said Scott Fuzer, director of the mergers-and-acquisitions practice at West Monroe Partners in Chicago. “The last several years have been, especially about two years ago, just record-setting in terms of the volume of transactions. So a lot of the pipeline, if you will, has been flushed.”

While the number of deals has tapered off, the dollar amount of the deals has risen, thanks to restricted inventory and private-equity funds flush with cash, Fuzer said.

“You’re probably getting a lot better purchase price for those organizations today then you would have, say four, five years ago,” he said. “The last thing a private-equity firm ever wants to do is give the money back to their investors because they can’t put it to work. That raises concerns about their ability to make deals happen.”

According to PitchBook, a Morningstar data company, in North America, 9,801 mergers and acquisitions came to fruition in 2016, down 24 percent from 12,832 in 2015. The total deal value was $1.4 trillion, down 7 percent from $1.5 trillion the year before.

The median value of individual deals edged up 20 percent, from $30 million in 2015 to $36 million in 2016. The average value of a deal climbed 36 percent, from $373 million to $508 million.

In Europe, the trend was even more pronounced, with 8,543 mergers and acquisitions in 2016, a dip of 23 percent from 11,087 the year before, whereas total value rose 9.5 percent to $746 billion from $681 billion.

The elephant in the room — Amazon.com Inc.’s proposed takeover of Whole Foods Market Inc. — has pummeled grocery stocks and sent a chill down the spine of potential IPOs.

“That kind of stuff is exactly why a lot of my clients just get really scared of either being publicly traded or losing control of their company. Because I don’t think Whole Foods would have been in that deal or looking for it at all if it were not for that activist private-equity investor who built up a 10 percent stake in Whole Foods,” said Stuart Sullivan, private banking manager for Arvest Bank in Oklahoma City.

The Amazon deal doesn’t really represent the typical targeted takeover, though, said Jerry Larson, managing director of public accounting, consulting, and technology firm Crowe Horwath LLP in Chicago.

“The mega-deals get a lot of the press, but it’s not the center of the bell curve of the M&A volume market. … Middle-market companies and small and midsize businesses is where the largest volume is. Not necessarily the largest aggregate dollars. But once you get into that space, the businesses tend to be private. So it’s more likely that they will be part of a strategy for an exit of a family or some other reason. Or that company selling out to private equity to obtain access to growth capital.”

So what is the best move for a company when a potential suitor comes calling? Negotiate for a higher price? Try to find a better offer? Dilute your market share to avoid the sale?

All three experts agreed the answer depends on the individual needs of the company.

“When they come to me and say that ‘these people want to buy the company up, and I don’t want to sell to them,’ I’ll generally ask why. And it’s almost always around price,” Sullivan said. “They’ll say it’s worth way more than that. And I will say yes it is. With YOU. You are really the value of the company. Without you, this whole thing falls apart. Because you are the entire C-suite by yourself. And you own all the relationships that are important for the company. So if you get hit by a truck, it doesn’t matter if someone can buy this company. It doesn’t have nearly the cash flow that it does with you at the helm.”

Sullivan said selling the business is often the right move, though, for company founders.

“They can invent stuff, and they can carry the vision forward. But scaling is a whole different skill set. It’s very rare that a person who starts a business is the right person to grow it,” he said.

Another option available to a targeted company is executing a shareholder redistribution plan, a so-called “poison pill.” The tactic has been controversial since its introduction in the 1980s.

“The stock market reaction to adoption has been thoroughly inconclusive. Studies say it’s good, it’s bad, they really are all over the map,” said Peer Fiss, a professor of management and organization at the University of Southern California.

Fiss co-authored a 2014 study, published in the Academy of Management Journal, that looked at the effects after a company disclosed its intention to execute a poison pill.

“Just how we talk about that, your announcement, has an effect on the stock market. The stock market likes explanations or accounts that are more aligned with their expectations, and evaluate those data,” Fiss said. “But beyond that, it also matters who is speaking. Is it somebody who is obviously self-interested or who looks more reliable? And then, in what context.

“So if you’ve had a company that’s been doing really well, and they say, ‘look, we’ve been generating good returns for you, and now we’re adding a pill,’ really it’s for your protection,” he said. “The market liked that a lot better than if you have a company that has weak prior performance, and they’re saying now we’re adding a pill — that looks a lot more like management entrenchment.”

(c) 2017 Rochester Business Journal. To obtain permission to reprint this article, call 585-363-7269 or email [email protected].