What is the logic behind using exit multiple for terminal value?

For one of the interviews I had, the interviewer asked me the logic behind using exit multiples, I screwed up the answer cuz I have never really thought about why we could use an exit multiple to calc TV (Any input would be most appreciated).

I also have trouble understanding why it would even make sense to apply comp multiples, which are collected from the present time, to the subject company's EBITDA or revenue at a time so far into the future.

In addition, do we usually use LTM EBITDA or current EBITDA or future EBITDA for the exit multiple? How do we select exit multiple, by taking the average trading multiples of similar comps over the past years or....?

Thx a million guys!!!

 
Best Response

I'd approach it from the perspective of the Gordon growth model. You'll recall GGM assumes once a company hits stable growth, then price = dividend/ (cost of equity - long term growth rate)

Conceptually, shift this back from equity valuation to firm valuation. EV = cash flow to to the firm / (k - g)

Treat EBITDA as a proxy for cash flow. Then you get EV = EBITDA/ (k-g)

Using simple equations to shift this around, EV/EBITDA = 1/(k-g) = an EBITDA valuation multiple.

Ergo, we use a valuation multiple for terminal value for the same reason we use the GGM for long term valuation on a business when it is in a stage of stable growth.

Then go back to your university notes on why we use GGM. Those are your reasons why you use multiple for TV.

Where is it not appropriate to use a multiple for TV? Where the GGM assumptions don't hold. Which is usually where the company is not yet in its long term, mature growth rate, or where the company is in decline.

EDIT: You can use this same logic to understand why multiples may be higher or lower for a company ie that should be a product of 1/(k-g).

Those who can, do. Those who can't, post threads about how to do it on WSO.
 

Hey SSits, your comment is very helpful. Another quick question, do bankers usually use EV/LTM EBITDA, or EV/current year EBITDA or EV/Projected EBITDA for exit multiple? Thx a lot!!!

 

Typically the first or the second, but on a pro forma basis. For example, if the company has signs up a 3 year contract in November, the pro forma LTM EBITDA will be adjusted by the amount of EBITDA that contract would have contributed if it had been in place for the LTM. Similarly, if the company had gone through an efficiency review in the last 6 months, spending $5m on consultants to cut $20m of costs out of SG&A, both the $5m and $20m will be added back to pro forma LTM EBITDA to reflect the business EBITDA generation capacity as it is now. You'll normally get a quality of earnings (QOE) report from a good accounting firm which signs off on the pro forma adjustments.

LTM EBITDA and current year EBITDA (if you're close enough to year end) is "real" EBITDA. Projected EBITDA is more speculative, less reliable.

In terms of how close you need to be to year end - a deal going into debt syndication now or in December would still be sold off LTM 30 September EBITDA.

Those who can, do. Those who can't, post threads about how to do it on WSO.
 

Non occaecati ipsum veritatis doloremque aliquid. Et non molestias ut ipsum qui quam tenetur.

Ipsum et incidunt nam minus culpa. Eos et deserunt iure non sed. Ipsam accusantium nam architecto. Fuga quo cupiditate enim aut perferendis perspiciatis tenetur quia.

Career Advancement Opportunities

May 2024 Investment Banking

  • Jefferies & Company 02 99.4%
  • Goldman Sachs 19 98.8%
  • Harris Williams & Co. New 98.3%
  • Lazard Freres 02 97.7%
  • JPMorgan Chase 04 97.1%

Overall Employee Satisfaction

May 2024 Investment Banking

  • Harris Williams & Co. 18 99.4%
  • JPMorgan Chase 10 98.8%
  • Lazard Freres 05 98.3%
  • Morgan Stanley 07 97.7%
  • William Blair 03 97.1%

Professional Growth Opportunities

May 2024 Investment Banking

  • Lazard Freres 01 99.4%
  • Jefferies & Company 02 98.8%
  • Goldman Sachs 17 98.3%
  • Moelis & Company 07 97.7%
  • JPMorgan Chase 05 97.1%

Total Avg Compensation

May 2024 Investment Banking

  • Director/MD (5) $648
  • Vice President (20) $385
  • Associates (89) $259
  • 3rd+ Year Analyst (14) $181
  • Intern/Summer Associate (33) $170
  • 2nd Year Analyst (67) $168
  • 1st Year Analyst (205) $159
  • Intern/Summer Analyst (146) $101
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
Secyh62's picture
Secyh62
99.0
3
Betsy Massar's picture
Betsy Massar
99.0
4
BankonBanking's picture
BankonBanking
99.0
5
GameTheory's picture
GameTheory
98.9
6
CompBanker's picture
CompBanker
98.9
7
kanon's picture
kanon
98.9
8
dosk17's picture
dosk17
98.9
9
DrApeman's picture
DrApeman
98.8
10
bolo up's picture
bolo up
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”