Comments (31)

  • Anonymous Monkey's picture
  • Anonymous Monkey
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Feb 20, 2009 - 12:14pm
Anonymous Monkey, what's your opinion? Comment below:
Apr 5, 2008 - 1:42am
Alex_Kap, what's your opinion? Comment below:

Not sure who compares Cap/EBITDA, its EV/EBITDA, as Cap would look at equity holders, but ebitda goes to debt and equity so it its likeing EV/NI, doesn't make sense either.

Easiest way to get an exit is to find comparable exits and use that as an analysis. Comparable is what's hardest to find at times. If you want to see what market places comps firm vaue then you would have to compare equal terms or LTM to make it comparable.

  • 4
Apr 5, 2008 - 4:46am
dosk17, what's your opinion? Comment below:

Generally you assume the same exit multiple and purchase multiple. The purchase multiple would be either:

1) Based on public seller premiums if it's a public company, as well as other valuation metrics such as comps, DCF, etc.

2) Just based on comps if it's a private seller.

Some PE firms have made a lot of money by buying companies in cyclical industries during "down" times and then selling on the upswing. And it's likely the exit multiple won't in fact be the same as the purchase multiple.

But that's still the safest assumption; sometimes we are actually more conservative and assume a lower exit multiple if, for example, the growth rate slows by the end of the investment period.

Apr 5, 2008 - 10:30am
mlamb93, what's your opinion? Comment below:

What dosk said is true. One important thing to note is that multiples (in general) fluctuate with the health of the market. Back when the LBO boom was in its prime, multiples that PE firms paid for targets were borderline absurd. Think about it - if you bought a company for 9x EBITDA all-in (assuming no earn out) you really don't have much room to create value in the form of multiple expansion. EBITDA growth is really the only other long-term option. Without both, it's difficult to produce the 30%+ IRR most PE firms shoot for. This is even harder in today's world with the debt markets in their current condition.

All in all, if you're doing an LBO analysis, I would recommend you run a few scenarios (i.e. selling at same multiple with higher EBITDA, selling at higher multiple with higher EBITDA, etc.) This will help you determine how much value creation comes from each.

Quick note: if you're looking at multiples for private firm transactions, make sure you take each with a grain of sand. I saw this because - sometimes these reported multiples aren't off proforma EBITDA. They also may contain an earn out, that can make 6x look like an 8x.

Apr 5, 2008 - 10:49am
GenghisKhan, what's your opinion? Comment below:

the EBITDA exit multiples method is badly flawed, because it is predicated upon the "greater fool" theory. I bought it for 8x, and I am basing my returns on the assuming that a bigger fool will pay 8x for it in five years.

The practitioners' mental shortcut makes this method more common than the perpetual growth basis, but never mistake common for correct. You typically see bankers run 5-year DCFs with exit multiple approximating entry multiples or cycle average multiples. This is so that you don't get any "juice" from multiple expansion or contraction in your assumption. But it's flawed because of that inherent assumption that someone else will be as silly as you are.

Here are some things you should think about: why a five year DCF? Why should the terminal value be a year 5 multiple? If it is, does a company continue to grow at 20% in perpetuity - ever? History tells us no. In fact, evidence would point you to the fact that all companies converge upon GDP growth (or lower, given the entry of new fast growing firms), over time.

So terminal value should be based on an EBITDA multiple or perpetual growth rate that approximates GDP, no? Absolutely, from a theoretical basis. But will Google be GDP in 5 years? Unlikely. So the right argument is that terminal value should reflect the steady state of the business, that portion that occurs when it does become a GDP-type company. And the interim period DCF should go as long as it takes to get there (10 years, perhaps).

At that point, capex and D&A should not impact the EBITDA versus ULFCF question because the two should converge in a steady state business, right?

That's the correct way to do a DCF. That's what our guys get from me when I sit on their fairness committee.

Still, I know that's not typically the way firms do DCFs. One, because it's hard to get good projections for more than a few years. Two, because bankers like the EBITDA exit multiple method (most firms are not particularly academic in their approach to finance).

Regardless, that's not an excuse not to be able to argue the point fluently. At some point you'll be in a board meeting, and some finance geek will grill you on why you used the arithmetic versus the geometric equity risk premium, or the abbreviated period versus since-inception, or raw versus unadjusted beta, or used a size premium or not. And you'll either stare at him like a deer in the headlights, or you'll calmly but forcefully say: "You raise a good point, but let me explain why that's not the appropriate approach for this type of analysis..."

Apr 5, 2008 - 11:50am
boredom, what's your opinion? Comment below:
GenghisKhan:
Still, I know that's not typically the way firms do DCFs. One, because it's hard to get good projections for more than a few years. Two, because bankers like the EBITDA exit multiple method (most firms are not particularly academic in their approach to finance).

That last part about most firms not being particularly academic in their approach to finance has me curious. Are there some firms that are generally more likely to have people whipping out the Damodaran books? If so, could you name which ones have a reputation for taking a more academic approach, and which ones are known not to? Perhaps it depends more on which group you're part of?

On that same note, I've been wondering about where the technical judgment or knowledge resides in the hierarchy. Is it up to associates and analysts to come up with what's considered a solid valuation (i.e. make decisions on how certain premiums are calculated, etc.), or who runs the show there? I've heard conflicting things on the involvement (or lack thereof) of VPs/SVPs/MDs in the process.

Jun 24, 2008 - 7:44pm
GenghisKhan, what's your opinion? Comment below:
boredom:
GenghisKhan:
Still, I know that's not typically the way firms do DCFs. One, because it's hard to get good projections for more than a few years. Two, because bankers like the EBITDA exit multiple method (most firms are not particularly academic in their approach to finance).

That last part about most firms not being particularly academic in their approach to finance has me curious. Are there some firms that are generally more likely to have people whipping out the Damodaran books? If so, could you name which ones have a reputation for taking a more academic approach, and which ones are known not to? Perhaps it depends more on which group you're part of?

On that same note, I've been wondering about where the technical judgment or knowledge resides in the hierarchy. Is it up to associates and analysts to come up with what's considered a solid valuation (i.e. make decisions on how certain premiums are calculated, etc.), or who runs the show there? I've heard conflicting things on the involvement (or lack thereof) of VPs/SVPs/MDs in the process.

Boredom, yes, there are firms that I believe are more "academic" in their approach. JPM is a good example of this. From their insistence upon mid-period discounting to their establishment of an M&A Research department (sort of a b-school finance professor type group) to their use of "risk factors" in lieu of a traditional beta, JPM has always been in my mind more cerebral than the typical M&A group.

The question you ask about WHERE the institutional knowledge resides is actually an enormously important question. In my opinion it's why it is a terrible mistake to disband M&A as a stand-alone group. The knowledge that resides among specialist practitioners fertilizes the entire firm. Things that tech groups never see may be second nature to, say, chemicals bankers. M&A branches across those and helps ensure that expertise crosses group boundaries.

That "guru" effect is why every firm has senior M&A professionals. The issue with integrating M&A into the industry groups is how you develop those future gurus without stand-alone M&A (unless you just intend to poach them from firms who have M&A groups).

Apr 5, 2008 - 10:54am
jajaja, what's your opinion? Comment below:

but in the real world, you determine the exit multiple by looking at the entry multiple, and making some finger in the air adjustment up or down depending on where you are guessing the cycle is going, and whether you are getting the company at a steal.

this is a terrible method, as the multiple can give huge swings to your valuation and make/break the deal. However i would argue it does at least as well as slaving the whole night to get 40 comps / prev transactions. reality is, the future is hard to predict, all you can do is build in as much cushion as you can afford

Apr 5, 2008 - 9:01pm
CDNmonkey, what's your opinion? Comment below:

Genghis, while I agree with your technical approach to the DCF method, I would argue the bigger problem is the projections. You mentioned this is why banks tend to use the 5 year + perpetuity model - since good projections aren't available.

I have confidence in a 5 year to perpetuity DCF model for companies like Wal-Mart, Home Depot, P&G, J&J, etc. It is not hard to see where these companies will approximately be 10-20 years. A few years of projections with EPS growing at (ROE * re-investment rate) to perpetuity is reasonable. (or EBIT/NOPLAT growth = ROIC * re-investment rate).

However, in banking we apply the DCF model to every company under the sun. Every company seems to have rising earnings and 3% perpetual growth rates. Unless a business has a durable competitive advantage, perpetual growth probably has zero value as capital expenditures are required to fund future growth. For a business without a long-term competitive advantage, returns on incremental capital deployed will probably equal WACC. There are plenty of exceptions of course...natural resources, non-asset based businesses, etc. As a corollary, I would also argue that for business without a strong competitive advantage, it is also tougher to predict if current earnings can be maintained far into the future. I'm not suggesting there is a better way - just that our industry seems to be very optomistic (as we are paid to be).

Based on my very limited experience and insight, it seems that bankers add far more value selling mediocre businesses than great ones. It is far easier to sell the future prospects of Allison Transmission than Jaguar Cars. Would this be a fair conclusion about M&A banking or am I way off?

Apr 5, 2008 - 10:19pm
slickmac, what's your opinion? Comment below:

Thanks for all of the input thus far. Let me pose an example so I can really determine whether I understand the concept. Suppose for example I am valuing Lockheed Martin (LMT). Let us assume that by some miracle, I have made accurate assumptions for short term growth rates and FCF projections. I then pull some of LMT's traditional comps and analyze their current EV / EBITDA multiples. Boeing CO: 7.87 TEXTRON INC: 13.3 ROCKWELL COLLINS INC: 10.09 etc.

Now I simply average out the multiples (I used 20 comps that averaged to approximately 10) and apply it to the last year's projected EBITDA and discount at WACC.

Feedback? Criticisms of comps? Direction? Thanks in advance.

Aug 2, 2012 - 11:53pm
SmalltownUSA, what's your opinion? Comment below:
slickmac:
Thanks for all of the input thus far. Let me pose an example so I can really determine whether I understand the concept. Suppose for example I am valuing Lockheed Martin (LMT). Let us assume that by some miracle, I have made accurate assumptions for short term growth rates and FCF projections. I then pull some of LMT's traditional comps and analyze their current EV / EBITDA multiples. Boeing CO: 7.87 TEXTRON INC: 13.3 ROCKWELL COLLINS INC: 10.09 etc.

Now I simply average out the multiples (I used 20 comps that averaged to approximately 10) and apply it to the last year's projected EBITDA and discount at WACC.

Feedback? Criticisms of comps? Direction? Thanks in advance.

Make sure that the comps have multiples within a reasonable range. It seems that 10 is within the spread, but any outliers would skew the average and a median would be more appropriate. Also, make sure that the multiples are from the same time frame (e.g. if one comp has a different year end than the company you value, be sure you are using the same LTM).

Aug 2, 2012 - 11:54pm
Theseus, what's your opinion? Comment below:

Steady State Exit Multiple (Originally Posted: 09/04/2012)

First post on here. FYI, I'm a BBA student graduating from a top 5 program this year, but still very unexperienced so don't be surprised to find some errors in here.

Last year I was working on a valuation model and an older classmate helped me to set up a broader value range using multiple versions of DCF analysis. I believe in addition to comps, LBO analysis, ect. there were three different versions of DCF used which varied only when computing the terminal value of the business.

The first two consisted of a continuous growth perpetuity model assuming growth equal to GDP and a terminal multiple. I can't remember how I found the terminal multiple to be honest, but I think I used a weighted average of the best comps I could find despite a fairly unique business model.

I can't seem to remember the third method, and I've struggled to find a good explanation online for what I'm searching for. I believe it consisted of finding the point where the PVGO was negligible and using that as a baseline valuation in case the firm was unable to continue growing after the 10-year forecast period. It also involved an exit multiple, but I have no idea how it was calculated. I remember it involved more arithmetic than the other method that used a TV multiple.

I know that seems pretty vague, but I'm hoping someone on here will have some idea what the method I'm trying to find is.

On a side note, is there any reason that I couldn't just use a perpetuity without growth to find this value? As in (FCFt/WACC)*(1/WACC^t) for the terminal value in this method or would that have different implications than a terminal multiple that assumes no growth.

Aug 2, 2012 - 11:55pm
Downtown, what's your opinion? Comment below:

I'll tackle these questions in order.

1) DCF using perpetuity growth rate for terminal value: it sounds like you understand how to calculate the terminal value this way (FCF*(1+g))/(WACC-g), but the point you're missing is that when you assume a growth rate and WACC you are essentially implying a terminal multiple of FCF....(1+g)/(WACC-g). So you can either look at this multiple of FCF directly or take the terminal value and divide by EBITDA to see what the implied EBITDA multiple is.

2) DCF using exit multiple for terminal value: the multiple you use should be based on mature companies operating in the same industry. Reason for this is that by the time in the future your DCF needs a terminal value, there shouldn't be any abnormally high growth opportunities left for the company. Obviously, you also want to make sure the multiples match (if using EBITDA mults for comps you need to multiply that against your company's EBITDA, not FCF...)

3) I had a little trouble following what you were saying for this alternate DCF, but it sounds like the residual income method. Residual Income Method basically states that your company is worth it's book value, plus any additional value it can generate by earning a ROE above its cost of equity. I rarely see this method used in i-banking, with the exception of financial companies where balance sheets and ROE are top of mind for investors....maybe just check around online for some more info on this and see if it answers your question.

4) You always want to have some growth rate in your perpetuity assumption, unless you really think the company is eventually going to go out of business. At the very least you'd expect the cashflows to grow by inflation (I'm assuming your WACC is a nominal rate and not real rate).

Hopefully that helps.

Best Response
Aug 2, 2012 - 11:56pm
cc66, what's your opinion? Comment below:

lbo model question - entry and exit multiples (Originally Posted: 01/13/2014)

Could anybody share some best practices for an enty and exit multiples table in an lbo model?

The exit multiple part seems easy because EBITDA is an output so you can calculate EV at various exit multiples. However, the entry multiple is an input, so I cannot think of a way to display various entry multiples at once other than running each one seperately and hardcoding the results, which does not seem ideal.

Thanks in advance!

Aug 3, 2012 - 12:03am
TheBigBambino, what's your opinion? Comment below:

Thanks a lot - I just used that combo in a LBO test and I think it shows a good range of outcomes to discuss while defending your model.

"If you want to succeed in this life, you need to understand that duty comes before rights and that responsibility precedes opportunity."
Aug 3, 2012 - 12:02am
Bullet-Tooth Tony, what's your opinion? Comment below:

There are several ways to do this.

The entry multiple can be dictated by a couple of factors. Most importantly is the returns you get from an expected exit multiple. You have a range of what specific PE funds may target given the target's characteristics. The easiest way is to set the exit multiple near/around today's market multiples. If you think a deal is going for 7x, then set the exit to 7x. By manipulating EV, you can narrow in on a range of entry multiples.

You could also take the opposite approach and say, I know this deal is going to be 7x, which gives you an entry EV. Then you look at the returns and leverage to adjust the exit multiple.

There is also the expected growth of the company. If you have a mature company with sub-5% growth, the Entry and Exits should match or perhaps even step down (.5x) considering we are in a "hot" market from a multiples standpoint. If you have a growth company, you can more easily justify multiple expansion without losing a grip on conservative assessment.

Apr 7, 2008 - 12:27am
ash37, what's your opinion? Comment below:

The issue with using trading multiples to project your perpetual growth is that firms often pay a premium over trading comps (to account for en bloc, synergies, forward tax credits, etc). Therefore, if exit multiple = initial multiple, then it does not equal your trading multiple for reasons stated earlier (unless the company you are looking at is another Bear Stearns and you can buy it for a fraction of its market price).

With respect to how you determine that multiple itself, try looking to see if there are any precedent transactions and look to apply their multiples.

Aug 3, 2012 - 12:04am
esther66, what's your opinion? Comment below:

Terminal Value - How to get exit multiples? (Originally Posted: 09/22/2014)

Hi guys, I just got this asked in an interview:

Say we have a 5-year forecasting period. In determining the terminal value, we want forward looking exit multiples and comp's EBITDA. How could we know the exit multiple of the now+5th year? What we could get is only the current trading multiples.

Say, if we are calculating the 5th year multiple by EV/EBITDA for 5 comps, it would be complicated projecting the 5th-year-EBITDAs for all of the 5 comps.

Thanks!

Aug 3, 2012 - 12:05am
notgs, what's your opinion? Comment below:

In your operating model (of the firm you are valuing), you will have the EBITDA in year 5.

Take that EBITDA and multiply by current EV/EBITDA. Later, you can plot a sensitivity table to see how it looks like with different figures. This is the best you can do.

There is no need to know EBITDA multiples 5 years into the future.

In your mind, I believe you are trying to "match" the timeline. There is no need to do so.

Aug 3, 2012 - 12:08am
azndarkvader, what's your opinion? Comment below:

Why use EV/EBITDA for exit multiple when you are projecting FCFF (Originally Posted: 12/03/2014)

1) Why do you use an exit multiple that's not consistent with what you're projecting? Shouldn't you use EV/FCFF

2) Along the same lines, if you use FCFE what exit multiple would you use. Wouldn't you use a equity multiple since you're finding the equity valuation so something like PE?

Aug 3, 2012 - 12:09am
Bullet-Tooth Tony, what's your opinion? Comment below:

You use multiples based on what type of exit multiple you will receive upon a sale. If buyers are giving you term sheets with valuations derived from EV/EBITDA, what good is it to use a different multiple to come up with your valuation? Match your valuation methodology to that used by buyers.

Aug 3, 2012 - 12:12am
Bullet-Tooth Tony, what's your opinion? Comment below:

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