Disposition of buyout - size discount
A PE shop acquires a company for lets say 150mm TEV with EBITDA of 15mm and an entry 10x multiple. Healthy company, with strong cash flows, top growth and profit margin relative to competitors, and debt free. Lets say this company was valued at the high end of its comparable range but was discounted at 20%ish to account for its smaller size and acquired at the 10x multiple listed above.
Fast forward 5 years - Ceteris paribus...growth is still good, debt free, etc. and the EBITDA is now 50mm. Obviously, there are numerous metrics, drivers, and fundamentals that go into valuation with a lot of moving parts, however, would the multiple still be discounted for size as much considering the company has grown substantially upon exit? If the entry multiple is applied, it would be worth ~500mm TEV. Still a private company as well. Hope my question makes sense.
When you say the company was valued at the high end of the range but was discounted 20% for size, what you're really saying is the company was valued at 20% below the high end of the range. What the 20% discount was for is completely subjective (was it size, cost of capital, uncertainty over growth projections, etc). At exit, what matters is what the next guy is willing to pay for the now larger business. So it's certainly a valid argument to say that the 20% discount should no longer apply, but it's also valid to say that it should. Making a multiple expansion argument is always a subjective thing, and there is no right or wrong answer until an exit actually takes place.
One way you could make this argument more solid is by using different sets of peers. If you can show that the smaller peers in the $15mm EBITDA range trade at a discount to the peers in the $50mm range, then at least you have some backup for the 20% expansion. In my experience the numbers rarely work out to such a clean answer... but you can always re-cut the peer sets to show whatever answer you're looking for, a game every investment banker is familiar with. Whether or not this holds true can only be answered at exit...
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