which valuation method would you bet on if you had to choose just one (comp, transactions, lbo, dcf) if you were on the buy-side and your job depended on it? - interview question
also, is it true that comparables would give you now higher multiples than precedent transactions?
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LBO for buy side
Why LBO?
Why not precedent transactions, which was the answer given by the interviewer.
LBO is going to back in to an implied IRR and will give you the maximum the client should pay. If you are a buyside advisor, this is the number you are looking for.
Multiples are going to "sometimes" produce the highest valuation. and thus are probably not the best for a buyside advisor
LBO gives you the lowest value among them all because of the high IRR, right? And isn't the LBO only for an LBO, so for an M&A buy-side (majority equity) you wouldn't use the LBO. Why not a DCF instead of an LBO.
Also, the answer by the interviewer was "precedent transaction" because they are the "best sanity check when all else fails". Thoughts?
With an LBO you would get a low value, like you said the maximum the buy side client wants to pay, but would you stick your neck out? Because when you lowball the offer you might not get it and then the deal goes to someone else because your valuation was too low.
“Valuation is an art not a science” rings really true here. I think you’re getting at the point that it depends on the situation but generally a DCF is highly speculative since anything can happen to throw off projected revenue - you can’t accurately predict the future. (A good example of this is how the consumer retail industry couldn’t predict the COVID pandemic preventing people from being able to shop in droves at their brick and mortar stores). So if you need to stick your neck out, you’d refer to precedents, which give you a range of acceptable multiples, beyond what the buyer is willing to pay in a LBO. Also DCF’s really favor sell side mandates because every company assumes they’re going to hit ridiculous short term revenue goals, there’s just too many assumptions to decide solely based off a DCF. I’d argue generally highest to lowest valuation would be: DCF > Comps > Precedents
The difference in an LBO and DCF mostly comes down to the cost of equity and cap structure assumptions. LBOs are basically just levered DCF tailored to the returns thresholds and hold periods for a typical private equity investment. You get a lower LBO valuation than a DCF because the WACC for a sponsor deal is usually higher due to target equity returns of 25% (plus potentially higher cost of debt due to higher leverage).
If I were "on the buy-side" as the question asks, I would likely say LBO because that technique would evaluate the target's cash flows and capital structure as well as multiples
LBO and yes.
I thought precedent transactions gave a higher multiple because of the control premium? Am I wrong?
Think this would depend on the industry. For example public tech companies tend to trade at extraordinarily high multiples but if you are looking at a tech company in the LMM market it’s make more sense to go by the multiples paid for companies of that size. There is a control premium for transactions in this case but it would be no material in comparison to the difference of multiples paid (6-9x ARR vs. 10-15x ARR of public comps)
Yes, but current valuations (for a lot of industries) are so high that they trump the 15% premium to less-overheated markets.
The one that generates the biggest fee
“for buyside” otherwise this would be the right answer lol
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