Hey all,
I know exit/terminal multiples are more prevalent in banking when estimating a terminal value for a company. What are the pros and cons of both methods?
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Major disadvantage of the perpetual growth methodology is that it is difficult to estimate an accurate perpetual growth rate for a business. With the exit multiple methodology you can use precedent transactions to estimate the exit multiple at the end of the projection period (although in reality multiples can change drastically over the period).
It all comes down to the fact that you can better defend your assumption using an exit multiple approach. In most instances the terminal calc. will drive a good portion of the value in the model, so this assumption is important.
Also, the exit multiple method typically is greater than a perpetuity calculation, which leads to a higher company valuation.
both methods do not always concur
reality check: calculating the perpetual growth rate implied in the TV multiple:
g =
(TV Multiple * EBITDAn * WACC) – FCFn
/
(TV Multiple * EBITDAn) + FCFn
ALWAYS calculate both to check them against each other.
The pros and cons of each method depend on the quality of your forecasts and the information that is available to you.
Remember, multiples should be based on normalized multiples at the END of a company’s projected horizon. In other words, select multiples from comparable companies that are similar today to what your company will look like at the end of your forecasted horizon.
If the business is assumed to be sold at the end of the projection period (i.e., LBO), the exit multiples should generally be based on “acquisition comps,” as opposed to “trading comps" (i.e., should include a control premium)
If using the perpetuity growth method, the rate should be consistent with company’s expected long-term industry growth rate, inflation rate, and the overall domestic and global economic growth rate (GDP). Remember, the perpetual growth rate cannot be higher than the GDP rate and cannot be lower than inflation.
Thank you all for your input, very helpful.
they don't have any difference but one...
as people already pointed before, when you use a multiple, you imply growth. when you use growth, you imply a multiple. So essentially growth is the fundamental driver to both methods. 7x EBITDA multiple means nothing more and nothing less than a xx growth rate that will justify this multiple.
the reason why people talk more about exit multiples than growth is that it is easier to compare to the trading comps. people usually talk about companies trading at xx multiple rather than xx growth rate.
rmivalue:
Thanks for the info - out of curiosity I derived that equation myself and got a somewhat different result. Mind sharing how you arrived there?
Assuming: FCFn / (WACC - g) = (EBITDAn * TV Multiple) FCFn = (EBITDAn * TV Multiple) * (WACC - g) WACC - g = FCFn / (EBITDAn * TV Multiple) g = WACC - FCFn / (EBITDAn * TV Multiple)
g = ((EBITDA * TV Multiple * WACC) - FCFn) / (EBITDAn * TV Multiple)
Same as yours but without a + FCFn in the denominator. Let me know if I missed something. Thanks!
Calculating terminal value - Gordon Growth or Multiple (Originally Posted: 11/27/2012)
Hi everyone,
I was thinking of putting together a valuation model using DCF, comps, and precedent transactions to show interest in and ability to do the work. I was wondering if you guys most often use exit multiples of Gordon growth for terminal value in practice. What growth rates do you guys usually use (growth in GDP, etc)? Also how do you guys find exit multiples in practice? I do not have CapIQ access so was wondering on what databases i may use. I do have access to Thompson Reuters.
Thanks everyone!
Generally we show both methods in our valuation analysis at our firm. If you use the terminal multiple method, you will have an implied growth rate and vice versa.
Growth rate will be company specific. Easy way to find growth rate if you have no idea is to start with the terminal multiple method and back into an implied growth rate. exit multiples come from the comps. If the current forward EBITDA multiples are 7.0x then that would be your exit multiple. Obviously this multiple is subject to a lot of factors, but that is one way to get it.
To get a multiple for the comps you have to calculate EV (SEC Filings and Mkt. Cap info from Yahoo Finance) and some underlying EBITDA metric (estimates you can get from Thompson).
I'm pretty sure Yahoo finance uses Cap IQ info. Not sure how fresh it is tho, or how often it is updated.
During my internship, I used both. However, more merit was weighted towards the exit multiple method; this is what my MD said. Most of the companies that my boutique worked with were domiciled in North America so I used a perpetual growth rate of ~3% (GDP growth). If you are doing this to show interest, you can only utilize the resources you are given, right. So, use Yahoo finance for the multiples, but when you are projecting your CFs, you can just grow them at the 5-year CAGR.
^ interesting. During my internship they definitely preferred perpetuity growth as opposed to exit multiple. Of course, it depends on the industry and stage of your company as well. Obviously perpetuity growth at GDP would make more sense for a utilities company than, say, a SaaS startup.
Thanks guys! I was also wondering how do you guys forecast changes in NWC y-o-y?
A/R = A/R Days Inventory = Inventory Days Other Current Assets = % of Sales A/P = A/P Days Accrued Expenses = % of Sales Other Current Liabilities = % of Sales
Total change Y-o-Y is your investment in NWC
Why is my TV using Gordon Growth higher than Exit Multiple? (Originally Posted: 08/29/2014)
Hi monkeys. Conducting a DCF using Gordon Growth with perpetual growth of 2.5% and Exit Multiple of 3x, but the Gordon Growth Method is giving me a terminal value of 14mm while the Exit Multiple Method is giving me 8mm. I thought Gordon Growth was supposed to be the more conservative estimate? Any suggestions? The formula I'm using for Gordon Growth is: EBITDA x ((1 + terminal growth Rate) / (WACC – Terminal Growth Rate)).
Appreciate any feedback.
The assumption that the growth method is more conservative depends on your exit multiple assumptions. Why 3.0x? Seems quite low. Throw in something more in line with the market like 10.0x and then see what is more conservative.
That makes a lot more sense - my exit multiple is probably just too low. Thanks for the suggestion AZ34.
Note that exit multiple varies by industry. Utilize precedent transactions to get a picture of where people in the industry typically exit.
3x is likely a very conservation exit multiple
Gordon Growth Long-Term Growth Rate (Originally Posted: 11/16/2012)
Has anyone used a negative long-term growth rate in a Gordon Growth model? Would there be a circumstance where this would be acceptable? Thanks!
If you were to forecast a consistent deflationary environment going off into perpetuity (forever) or a continuously strangled/stagnant business model then maybe, but i've never seen it.
Even if the business isn't going to grow materially, you can still grow it's nominal cash flow through inflation expectations.
gordon growth model (Originally Posted: 04/04/2008)
given that we have all the available info to calculate the GGM, do we use bond yield + e(rp) or CAPM to calculate cost of equity? why do we choose one over the other?
why are there 2 methods to calc Ke?
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