Valuation Multiples Research Articles

Spin‐offs: Tackling the Conglomerate Discount

Spin‐offs and other restructuring actions have risen sharply in 2011, driven by the need to streamline business models and increase corporate values. These transactions can be an effective tool for addressing the conglomerate valuation discount that has been a pervasive phenomenon over the past decade, affecting conglomerates in most regions across the world.In particular, North American and Western European conglomerates trade at valuation multiples that are roughly 10% lower than those of their pure‐play peers. A conglomerate discount also prevails in some of the emerging markets, including CEEMEA and Asia. Nevertheless, in some regions, notably Japan and Latin America, conglomerates typically trade at a premium. Although the average conglomerate discount narrowed during the financial crisis due to the perceived benefits of diversification during downturns, almost half of the conglomerates globally trade at a discount, and almost a third of all conglomerates have persistently traded at a discount during the past five years.For such companies, fixing the discount requires a simplification of the business model. The authors show that recent announcements of spin‐offs have led to significant share price outperformance by the parent company in both the short and the longterm, highlighting their effectiveness as a tool to enhance valuation. Spin‐offs can be particularly attractive for those conglomerates that operate unrelated business segments since these firms trade at a sharper discount than diversified firms operating in related businesses. The authors discuss how management should think about the financial implications of spin‐offs, including capital structure considerations, dividend policy, and turnover in the shareholder base.

Valuing Internet companies: a DEA-based Multiple Valuation Approach

The Internet industry has created a great deal of marvels over the past decade. Assessing Internet companies’ values provides an alternative tool to help make better investment decisions. This paper presents a hybrid of both DEA and multiple valuation methods to valuate Internet companies. Four tailored valuation methods were proposed and a sample of 52 firms was tested based on Price-to-Gross Margin ratio. With the focus on the estimation direction (overvalued/undervalued), verified with the real prices, an accuracy rate of approximately 70% on average has been obtained from these four methods. The proposed methods allow investors to have a more accurate estimation of the subject company's current and future stock prices. This implies that the research results could help investors when they are making long-term or short-term investments.

International equity valuation: the relative importance of country and industry factors versus company‐specific financial reporting information

AbstractThe relative importance of country‐ and industry‐specified factors vis‐à‐vis company‐specific financial statement–based information in explaining equity valuation multiples in an international setting is examined. Both country‐specific effects via previously identified variables and an indicator variable approach are analysed. While company‐specific factors are predominant in explaining cross‐sectional differences in valuation, country and industry factors have sizable incremental explanatory power over them; the latter are not independent, so their relative importance is influenced by how we adjust for this commonality. Using country indicators provides larger incremental explanatory power than using country‐specific factors, suggesting that previously identified factors may be measured with sizeable error or omitted factors are important.

Window Dressing of Short-Term Borrowings

We investigate the extent to which banks’ quarter-end borrowings in the repurchase market deviate from within-quarter levels, and associated factors. Quarter-end repo liabilities are materially lower than within-quarter averages for a large fraction of sample banks. These deviations are more pronounced at banks with a higher concentration of repo borrowings in their liability structure and with larger absolute trading gains or losses. Furthermore, the association with trading activity is mitigated when banks are better capitalized. We also find that these deviations are associated with bank depositor and borrower behavior. Together, the evidence suggests that deviations reflect both active window dressing and passive customer-driven liquidity dynamics. We document that unexpected downward quarter-end deviations in repo liabilities are associated with adverse short-term capital market consequences. Over the long term, banks with more frequent downward quarter-end deviations exhibit higher credit risk, but we find mixed evidence for equity market valuation multiples.

Do Buyouts (Still) Create Value?

ABSTRACTWe examine how leveraged buyouts from the most recent wave of public to private transactions created value. Buyouts completed between 1990 and 2006 are more conservatively priced and less levered than their predecessors from the 1980s. For deals with post‐buyout data available, median market‐ and risk‐adjusted returns to pre‐ (post‐) buyout capital invested are 72.5% (40.9%). In contrast, gains in operating performance are either comparable to or slightly exceed those observed for benchmark firms. Increases in industry valuation multiples and realized tax benefits from increasing leverage, while private, are each economically as important as operating gains in explaining realized returns.

The Impact of Common Advisors on Mergers and Acquisitions

We examine the conflict of interest that an investment bank faces when advising both the target and acquirer in a merger or acquisition (M&A) by investigating how common advisors affect deal outcomes. We compare M&As with common advisors to deals in which targets and acquirers use different advisors and account for the endogenous nature of this choice. We find that (1) deals with common advisors are less likely to be completed and take longer to resolve, and (2) sharing advisors does not affect the wealth gains of shareholders of targets, acquirers or the combined firm and the post-acquisition performance of acquirers. We find some evidence that valuation multiples paid for targets and deal premiums for public targets are significantly lower in transactions with common advisors, suggesting that common advisors tend to favor acquirers over targets, with an eye on future investment banking business from the larger, surviving firm. But most of our results suggest that common M&A advisors lead to neither better deal outcomes by facilitating information flow between targets and acquirers, nor worse deal outcomes by influencing both sides to hasten deal completion.

The Valuation Premium of the Common Stocks of Islamic Financial Institutions

The study examines the valuation premiums paid by investors for the common stocks of Islamic financial institutions in the United Arab Emirates (UAE). The UAE stock markets, during the period 2001-2005, were dominated by financial institutions which counted for 58% of all listed stocks. The study employs the price to book and the price to sales valuation multiples. Valuation by price to book value is more relevant and accurate for financial firms due to the high liquidity of their assets. It is found that there is a strong clientele preference for Islamic stocks despite the modest financial performance achieved in comparison with other financial institutions and insurance companies. The clientele preference in the UAE, measured by higher valuation premium, is for Islamic financial institutions first followed by commercial banks and last by traditional insurance companies and financial services companies.

An Empirical Study of Country Risk Adjustments to Market Multiples Valuation in Emerging Markets: the Case for Russia

Valuation in emerging markets is always a challenge. The existence of sovereign risk and capital market segmentation as well as small trading volumes and narrow domestic capital market make it difficult to identify peer companies for market multiples valuation without cross- border comparables. This paper investigates the practical implementation of market multiples valuation in emerging markets when the analyst should involve peer companies from developed markets. Companies with comparable operational parameters bear different values on different financial markets. The problem of unavoidable difference among national stock markets exists, that is why methods of cross-border multiples’ corrections are called for. We address cross-border corrections procedures for adjusting multiples to a sovereign risk to find out the role and the extent of these type of adjustments in valuation. We are using the samples of Russian and US companies to test three different adjustments’ techniques: the sovereign spread, the relative market coefficients and the regression approach.

Valuation of cancer and microbial disease risk reductions in municipal drinking water: An analysis of risk context using multiple valuation methods

We examine the value of health risk reductions (microbial illnesses/deaths and bladder cancer illnesses/deaths) in the context of drinking water quality treatment by public systems. When we assume that combined mortality and morbidity risk reductions are equally spread in the future; our results suggest that microbial risk-reduction programs have higher value than cancer risk-reduction programs, but that mortality risk reduction values are not significantly different for cancer and microbials. However, when a 25-year cancer latency is accounted for and a 5% discount rate is used, the value of cancer mortality risk reductions exceeds the value for microbial risk reductions. We also address a number of methodological issues, including performance of alternative choice experiment estimation (CE) techniques, relationship of CE to contingent valuation results, and implications for incorporating morbidity and mortality endpoints in the same survey instrument.

Does Investor Relations Add Value?

IR professionals argue that good investor relations contributes to the “fair valuation of firms”. We test the proposition that effective communication of accounting and other firm-specific information enhances firm value directly employing a unique and large database of firms nominated for Investor Relations Magazine’s ‘best overall IR’ awards measuring investor relations quality. We find firms perceived by investment professionals as having superior IR have increased analyst following, and improved liquidity in the year after award nominations. Effective IR also leads to subsequent positive abnormal returns, and such firms are additionally rewarded with significantly higher valuation multiples within the Ohlson (1995) framework. Overall, our findings are strongest for smaller firms which are more likely to be ‘neglected’. Our evidence is consistent with good IR successfully reducing the risk to investors associated with high information asymmetry. We also find our results are unlikely to be driven by potential sample selection bias.

All Eyes on Asset Quality: Microfinance Global Valuation Survey 2010

The past year held many challenges for microfinance: not since the Asian crisis of the late 1990s has the sector faced a more difficult economic environment. Yet despite these conditions, most micro-finance institutions (MFIs) proved to be up to the challenge. Beginning in January 2009, MFI portfolio delinquency levels began to deteriorate rapidly, with loans past due over 30 days (portfolio at risk [PAR30]) jumping from a median of 2.2 percent to 4.7 percent during the first five months of 2009, while profitability dropped from a median return on equity (ROE) of nearly 18 percent at year-end 2008 to 6 percent by May 2009. However, since June 2009 delinquency has moderated and profitability levels have come back to stabilize at 4 percent for PAR30 and 10 percent for ROE, respectively. Most MFIs continue to maintain solid reserve and capitalization levels, with equity ratios unchanged from the 18-20 percent range established over the past two years. This occasional paper aims to shed new light on equity valuation trends in microfinance, which must necessarily begin with a detailed examination of how MFIs have coped during the recent economic crisis. Accordingly, the first part of the paper is devoted to MFI asset quality and its impact on microfinance profitability. Next, the authors examine trends in valuation benchmarks for microfinance private equity transactions and analyze the key drivers behind these valuations. This section also delves into the recent growth in transaction volume and valuation multiples in India, which had a particularly active market in 2009. Finally, the authors seek to place the microfinance equity market within the context of the broader equity market, using comparisons with publicly listed low-income financial Institutions (LIFIs) in developing countries.

The Discount Premium between Private M&A and LBO Transactions

Financial buyers consistently paid their acquisitions cheaper than strategic buyers did in the 1990 (Butler 2001). One of the explanations is that they follow a dispassionate approach as they screen a dozen of deals for each transaction. Strategic buyers are restricted to their industry sector and therefore to a few targets. One other explanation is that financial buyers have developed good negotiation skill. They also overestimate synergies and can get carried away in the auction process (Roll 1986, Gaughan 2002). In this study, we seek to establish the existence of discount premium applied by financial buyers. Our study is important because the extant practitioner and academic literature tends to equate a discount premium with a liquidity discount. While the market prices of public companies are readily available, pricing information about private firms is scarce. The method of comparables along with estimates of the discount premium are routinely used to value private firms, typically in conjunction with valuation approaches such as forecasting and discounting future cash flows. The starting point in the method of comparables is to identify comparable public firms and determine an appropriate public-firm valuation multiple of an accounting fundamental. Using a novel data of 200 private LBO and M&A European transactions in small and midcaps, this article explain the reasons of this difference and estimate the discount premium between M&A and LBO transactions for the period 2004-2007. We follow the same methodology used by Koplein et al (2000), and Officer (2007). We have identified a set of acquisitions made by private equity firms with LBO. For each LBO transactions, we have identified an acquisition of private company, in the same industry that was acquired around the same time and that was closest in size. Then we compare the valuation price paid by the financial and the strategic acquirer. Our inferences rely on the use of enterprise-value-to-EBITDA (EV/EBITDA) and enterprise-value-to-sales (EV/SALES) multiples, two valuation multiples widely used in practice. The principal findings of our research can be summarized as follows: French LBO transactions are acquired at an average discount of 16.20 % to 17.25 % relative to similar French M&A transaction. UK LBO transactions are acquired at an average discount of 15% relative to similar UK M&A transaction. Both financial and strategic UK buyers paid their acquisitions higher than French and European buyers. Using both a univariate and a multivariate approach that overcome the selection biais due to difference in size and controls for differences in industry, firm size and growth, we find that financial buyers pays their acquisition lowers than strategic buyers with a discount premium that ranges from 16 and 24%.

Estimation of valuation multiples of Spanish unlisted food companies

In the valuation of Spanish unlisted companies, the most commonly used methods are the discounted cash flow, adjusted net book value and multiple valuation methodologies. The Spanish food industry mainly comprises unlisted SMEs (Small and Medium Enterprises) whereas the number of listed food companies is very low. In view of these two facts, there is practically no information on valuation multiples in this sector. In this context, a massive discounted cash flow model is created allowing for the obtainment of valuation multiples for small and medium-sized companies. Once the value of each company is obtained, the most common valuation multiples are calculated. The multiples which vary the least, and specifically the EV/EBITDA (Enterprise Value/Earnings Before Interest, Taxes, Depreciations and Amortisation) multiple, which presents the lowest interquartile range [10.32-14.78 in small companies] and coefficient of variation [0.43 in small companies], are most appropriate for use as a contrast and to aid in the valuation of companies. EV/EBITDA harmonic mean equals 11.51 for small companies and 11.88 for medium companies. Upon comparing the distribution of the multiples of small and medium-sized companies, no statistically significant differences were found.

Comparative performance of publicly listed construction companies: Australian evidence

Understanding the performance of publicly listed Australian construction companies, in comparison with other Australian listed companies, is vital to the construction sector’s continuous access to capital from the public equity market. Evidence on the performance of construction companies that do business in building and/or civil infrastructure is presented and compared with the Australian All Ordinaries Index and a portfolio of publicly listed (blue chip) companies. Using fundamental analysis, a comprehensive assessment on a range of financial and performance indicators is provided (including share prices, equity valuation multiples and profitability ratios) over the 10‐year period, 1998 to 2007. The results show that, apart from the period when the Goods and Services Tax was introduced in 2000, the performance of publicly listed Australian construction companies in most of the indicators assessed is comparable to the largest traded shares on the Australian Securities Exchange. The empirical evidence is encouraging and could potentially elicit interest and confidence for investors to invest in construction companies.

Are IPOs Really Underpriced or Overpriced: Evidence from Tehran Stock Exchange

While it is well documented in the literature that IPOs have been consistently underpriced on average of 15% or more over the past three decades all over the world, the recent seminal study by Purnanandam and Swaminathan (2004) report that IPOs are overvalued at the offer price relative to value metrics based on industry peer price multiples. Current study, applying residual income valuation (RIV) model along with comparable firm multiples valuation approach, replicates and expands upon the research by Purnanandam and Swaminathan (2004) by providing evidence from a sample of 162 IPOs floated during 1997-2009 in the Tehran Stock Exchange. The results suggest that: First, Iranian IPOs are underpriced on initial trading window of one month following issue on average of 13.93%. On the long-run performance, the average market-adjusted CARs and BHARs over three years after continuously listing are -6.67 and 0.00 percent, respectively. As a key finding of this study, the valuation results reveals that the sample Iranian IPOs are significantly overvalued compared to peer firms selected on industry and size, and also relative to their intrinsic value derived from the RIV model. This result is inconsistent with the traditional view (mainly asymmetric information based explanations) that IPOs are underpriced at offer price and fairly valued in the aftermarket relative to their matched comparable seasoned firms. However, this finding yields strong support for the investors' sentiment and fads and/or over-optimism argument in the literature.

But What Will it Do for My EPS? An Unflattering But Powerful Motive for Mergers

There is widespread evidence that bidders are more highly valued than their targets, and that both parties tend to be in temporarily high-valued industries. We find that valuation differences are also uniquely important for predicting who will be acquired and when. A firm is more likely to be a target when others in the industry could acquire them in a stock-swap merger that appears accretive to the buyer even after paying a substantial premium. The resulting measure is related to the dispersion of valuation multiples within an industry, but is grounded in a specific model of managerial behavior and is empirically much stronger than dispersion. Indeed, it is a stronger target predictor than any measure in the existing literature, including recent industry-level merger activity. Our results for bidders are less impressive. We find that a firm is more likely to be a bidder when it has more accretive targets, but unlike target prediction our effects are subsumed by existing size and valuation measures in the literature.

Highly Valued Equity and Discretionary Accruals

Abstract: Overvalued equity provides a strong incentive for managers to report earnings that do not disappoint the market ( Jensen, 2005). We find that this can be extended to highly valued equity more generally. In the year following the classification as highly valued and compared to firms with less extreme valuations, highly valued firms have significantly higher discretionary accruals and exhibit a more pronounced positive association between discretionary accruals and proxies for the likelihood of failing to meet earnings targets. These findings are consistent with the use of discretionary accruals to manage earnings in support of extreme valuation. Because highly valued equity will likely result in CEOs with valuable stock and stock option portfolios, we test whether and show that the overvalued equity incentive is incremental to a CEO's equity portfolio incentive. One implication is that directors and audit committees should be especially on guard for possible earnings management when a firm has extremely high valuation multiples and when the CEO has a lot of equity at risk.

The valuation by multiples of Italian firms

The purpose of this paper is twofold. First, the paper illustrates which comparables selection method provides the most accurate forecasts by using multiples. Firms listed on the Milan stock exchange from 2000 to 2006 were analyzed. Comparable firms were selected by activity sector, sector and size, sector and ROA, ROA and size, and were averaged with the arithmetic mean, median, and harmonic mean. Twelve multiple valuation methods were analyzed. The empirical results suggest that the selection of comparable firms on the basis of sector and ROA or sector and size are the most accurate criteria. Valuation improves when multiples are averaged using a median relative to arithmetic and harmonic mean. Moreover, in order to test which multiples are most effective to value a company, the main multiples were considered and I analyzed how factors such as sector, size and year bias these outcomes. The results show that the multiples based on cash flows are almost always significant; the multiples based on earnings are most significant in industrial sectors, in particular for small firms with many intangible assets; the multiples on book value appear most effective for non-industrial firms.

REIT Valuation Multiples

This paper examines the accuracy of valuation multiples in the Real Estate Investment Trusts (REITs) Industry. We evaluate fifteen multiples based on share price, enterprise value, and adjusted enterprise value. We construct benchmark multiples by grouping REITs into property categories. We place a given REIT into a group based on its property focus reported by SNL Financial and National Association of Real Estate Investment Trusts (NAREIT). The accuracy of valuation multiples are examined by using errors defined as the natural log of the estimated value to actual value ratio. Findings suggest that valuation errors are within a 15% threshold, mostly for enterprise value to EBITDA and enterprise value to EBIT multiples. In addition, we find that REIT specific multiples such as price-to-funds from operations, price-to- adjusted funds from operations, and price-to-NAV produce valuation errors less than that of earnings based multiples.

Valuation Multiples: Accuracy and Drivers Evidence from the European Stock Market

Abstract Market multiples are common and simplified tools used by the financial community for asset and company valuation, in which reference is made to previous transactions or “well-established” guideline companies in a particular industry. Though the simplicity of the method is indeed tempting, the inappropriate use of multiples may lead to erroneous reasoning and incorrect investment decisions, because there are a number of underlying assumptions comprising each valuation multiple. This article aims to analyze the accuracy of valuation multiples and to understand the financial drivers that explain the level of multiples. Using a sample of listed European firms, different financial ratios are analyzed, and the most appropriate drivers are selected. The article provides a few tips and hints to corporate executives and financial analysts in determining the factors to consider when using market multiples in their simplified analysis of investment opportunities.