Comps Calculation (Trading multiples)
How do you select the comparable companies for your target?
Let's say, company A is 3 years old with $5 million in revenue, providing software services in cloud computing. Would you select Oracle, Microsoft, Salesforce, Google, Linkedin, Facebook, AOL, IBM, ... for your comparable company analysis?
No doubt they provide similar (or same services or products) into the same or similar markets. They are competitors to each other with similar business characteristics, but their financial profile are different in size - the numbers are just too big for the large companies.
Can we compare Google/Microsoft with Company A - a $5 million start-up? Company A's ratios, returns, growth, margins will be different. In my opinion, they are not like-companies. In fact, a start-up requires 7 years on an average to become profitable. So, how can we actually compare its profitability with these giants?
Am I going wrong here? Any guidance will be of great help. Thanks in advance!
One of the main downsides of the comparable companies analysis is its almost impossible to select a peer group that all have similar traits(whether it be operations or financials). As you mentioned, resulting from this could be skewed multiples, i.e. Linkedin is trading at an extremely high premium because investors are optimistic of its future performance.
If you have access to Capital IQ/Bloomberg, try to dig up some equity research reports to see what analysts in the industry are using as their comps set, and they should shed some insight on their selections as well in the report. If possible, breaking down larger companies into specific business segments could paint a clearer picture, or even creating 2 peer groups if your target business can be segmented(have to do some in-depth digging in the 10-k).
If I break down the large enterprise into its business sgements, do I need to use only that segment's revenue? For example, Oracle cloud services - IaaS, PaaS, SaaS - generated about 35% of its total software revenue. Do I use this revenue to calculate ratios, profitability, growth, ...?
How do I calculate the EV, equity value, Debt, trading multiples, EBITDA, etc. related to the business segment? A company would raise capital for the entire organization rather than just for a business segment. Yes, it's possible to raise capital for a business segment, but there is always a holding company that divert such funds. For example, Oracle raise $10 billion in debt capital recently, but how do you know how are they using the capital in R&D, sales, product development, ... and for which segment?
Am I confusing?
Peer group in the proxy is a good starting point.
In reality, I don't think anyone goes to that extent. If there's no easy way to break down a businesses' segments, you'd just omit it from the comps set. Or, you'd just ignore that the company has multiple segments with different business models and competitive dynamics, and just go ahead and use the entire company. I've never seen any comps break down a business into its specific segments (doesn't mean that is hasn't happened). They're just not meant to be that complicated.
Sorry if my post was confusing, as Phoenix2017 mentioned it would be WAY too much work to break down a business and project statements for that specific segment. What I meant was breaking it down into "pure-play" segments to help identify a set of comparables for that segment.
For example, I recently did a deck for Indigo Books and Music Inc., a company that distributes printed books & toys(think Barnes & Noble). I created 2 peer groups- one with its main revenue stream being printed books i.e. Barnes & Noble, books-a-million and another set that sold toys & specialty consumer goods i.e. Hasbro, Mattel, etc.
By doing so, you'd have an overview of the 2 industries and weight your projected multiples more heavily to the side that your target's business model is focused on. In my example, lets say industry EV/EBITDA for print retailers was 4.0x, while for specialty goods it was 13.0x. Because 70% of Indigo's revenues are from printed books, I can rationalize that despite its product mix, it should be trading more similarly to the printed book industry.
StreetofBulls Thank you! I've witnessed some error while offering you a SB, but will definitely revisit to offer it again
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