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Comparable Company Analysis Hee Myoung Park The University of Texas at Dallas ENTP 3360.001 – Madison Pedigo

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Abstract We learned about the industry comparable analysis in chapter 5. Besides, there are various techniques for the valuation of company; such as trend analysis, precedent transactions analysis, or LBO analysis etc. People who work for investment or M&A company want to estimate and evaluate the financial situation of conglomerate or new and growing ventures. Through researching about the valuation methods, I have been interested in comparable company analysis. That was the reason I chose this topic for my research paper. First, I will explain about the definition and characteristics of comparable company analysis. After that, I will show you advantages & disadvantages of this method and one example of comparable company analysis.

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Comparable company analysis are a relative valuation that appraise a company by comparing valuation multiples and operating metrics to those of competitors. The competitors that have similar company size, industry focus, or financial characteristics are called “peer” and this peer group is the comparable “universe”. Because it is a rudimentary process to select a peer universe for a Comparable company analysis, it is very crucial part. According to The market approach to comparable company valuation, the selection of comparable companies is mainly driven
by two external determinants. The first one is the degree of similarity between the peer group

companies and the target company. This factor is a function of the availability of comparable companies in real valuation settings…. all articles, books and academic papers about comparable company valuation agree that comparable companies must have similar characteristics to the target company.(meitner, 2006) In general, comparable company analysis estimate a firm's value by multiplying a ratio estimated from comparable firms (valuation multiple) times the firm's earnings before interest, taxes, depreciation, and amortization (EBITDA), earnings before interest and taxes (EBIT), revenue, or some other performance measure. In our opinion, EBITDA has emerged as the most commonly accepted performance measure on which to base valuation multiples. (Finnerty & Emery, 2004) These multiples that we should use to compare comparable companies can be classified in two categories: Operating and Equity multiples. The operating outcomes of the business, such as revenues or EBITDA, are the operating multiples. Whereas equity multiples are the value produced from the business. P/E, P/B, and P/cash flow are the most commonly used multiples. Especially, P/E is the most broadly recognized in circles outside Wall street, multiples based on enterprise value are widely used by bankers because they are independent of capital structure and other factors unrelated to business operations. (Joshua & Joshua, 2013)

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Table 1 (Zhang, Jia, Gu & Li, 2011)

Spread key statistics, ratios, and trading multiples ▪ Size : sales, gross profit, EBITDA, EBIT, and net income ▪ Profitability : gross profit, EBITA, EBIT, and net income margins ▪ Growth profile : historical and estimated growth rates ▪ Return on investment : ROIC, ROE, ROA, and dividend yield ▪ Credit profile : leverage ratios, coverage ratios, and credit ratings

There are various definitions and categories for the valuation multiples. It means this analysis could be subjective because the selection of the peer universe and valuation ratio will be slightly different depend on who analyze. Comparable company analysis is relatively easy because the data for companies that are publicly traded is widely published. Therefore, this analysis is one of the most general valuation methods in real world. Many investors or market analysts use this technique commonly. However, comparable company analysis still has disadvantages. Pros ▪ Easy to calculate using widely available data ▪ Easy to communicate across a variety of market ▪ Determine a benchmark value for multples used in valuation ▪ Provide a useful way to assess market assumption of fundamental characteristics baked into valuations
Figure 1 (Joshua & Joshua, 2013)

Cons ▪ Influenced by temporary market conditions or non-fundamental factors ▪ Not useful when there are few or no comparable companies ▪ Can be difficult to find appropriate comparable companies for various reasons ▪ Less reliable when comparable companies are thinly traded

Comparable company analysis is designed to reflect “current” valuation based on prevailing market conditions and sentiment. As much, in many cases it is more relevant than intrinsic valuation analysis, such as discounted cash flow analysis. At the same time, market trading levels may be subject to periods of irrational investor sentiment that skew valuation

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either too high or too low. Furthermore, no two companies are exactly the same, so assigning a valuation based on the trading characteristics of similar companies may fail to accurately capture a given company’s true value. As a result, trading comparable company analysis should be used in conjunction with the other valuation methodologies. (Joshua & Joshua, 2013) If you have selected a relevant peer universe, now it is time to find the necessary financials to calculate multiples. The primary sources for finding financial information are the SEC website, NASDAQ, and Yahoo Finance. I select Starbucks and Yum Brands for example of comparable company analysis. Starbucks Market cap Enterprise value Sales Gross profit EBITDA EBIT Net income 61.16B 54.28 B 13.29 B 7.49B 2.86 B 2.09 B 1.72 B Mcdonalds 96.53B 110.38B 27.56 B 10.82 B 10.06B 8.59 B 5.58 B Yum 31.43 B 32.68 B 13.63 B 3.78 B 2.93 B 2.14 B 1.59 B

Figure 2 Data collected from Yahoo Finance

LTM Profitability Margins (%) Starbucks Gross profit EBITDA EBIT Net income 56.36 21.52 15.73 12.94 Mcdonalds 39.26 36.52 31.17 20.25 yum 27.73 21.50 15.70 11.67

Growth rates (%) star mcdonlads yum

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Revenue Gross profit EBITDA EBIT Net income

13.68 10.89 11.61 13.69 10.90

2.08 1.21 1.65 0.84 -0.69

7.98 8.31 18.94 29.29 21.08

Return on Investment (%) starbucks ROIC ROE ROA Dividend yield
Figure 3 Data collected from Yahoo Finance

mcdonalds 18.33 36.82 15.98 3.2

Yum 29.02 80.31 17.90 2.0

25.71 29.15 17.76 1.1

LTM Leverage & coverage Ratio starbucks Debt/asset Debt/equity Debt/EBITDA EBITDA/Int.Exp 0.06 0.10 0.18 117.77 mcdonalds 0.38 0.89 1.31 19.88 Yum 0.34 1.34 1.43 15.32

Figure 4 Data collected from Yahoo Finance

We have to look for a credit rating for each company. A credit rating is an assessment by an independent rating agency of a company’s ability and willingness to make full and timely payments of amounts due on its debt obligations…. The three primary credit rating agencies are Moody’s, S&P, and Fitch. Nearly every public debt issuer receives a rating form Moody’s, S&P, and/or Fitch. (Joshua & Joshua, 2013)

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Figure 5 (Joshua & Joshua, 2013)

Moody’s S&P

starbucks Baa2 A-

mcdonalds A2 A

yum Baa3 BBB

Figure 6 Data collected from Moody's and S&P

Once the key financial statistics are spread, the bankers proceeds to calculate the relevant trading multiples for the comparable universe. While various sectors may employ specialized or sector-specific valuation multiples, the most generic and widely used multiples employ a measure of market valuation in the numerator and a universal measure of financial performance in the denominator…. Among these multiples, EV/EBITDA and P/E are the most common. (Joshua & Joshua, 2013) I decide to use EV/EBITDA that is widely used enterprise value multiples. starbucks EV/EBITDA mean 18.97x 13.6967 mcdonalds 10.97 median 11.15 Yum 11.15x

EBITDA

Metric

Starbucks corporation Implied Valuation Range ($ in millions) Plus: Multiple Range Implied Equity Net Value

Implied Enterprise Value

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LTM

$1,860

10.95x – 18.97x

$20,367 $35,284

Debt 1,921

$22,2288 - $37,205

If there is any error such as incorrect assumption, wrong mathematical calculation, or incorrect financial information, it would affect to the result of this analysis significantly. In addition, if you choose more relative comparable companies from the industry, you can get tighter multiple range from this analysis.

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References meitner, M. (2006). The market approach to comparable company valuation. (p. 56). Physica-Verlag HD. Retrieved from http://link.springer.com.libproxy.utdallas.edu/book/10.1007/3-7908-1723-6 Zhang, J., Jia, Z., Gu, W., & Li, S. (2011, 08 16). Comparable analysis. Retrieved from http://www.slideshare.net/MsCellophane/comparable-analysis Finnerty, J. D., & Emery, D. R. (2004). The value of corporate control and the comparable company method of valuation. 33(1), 91-99. Retrieved from http://web.ebscohost.com.libproxy.utdallas.edu/ehost/detail?sid=89840832-810e-4c88-88ce217ef0fc584f@sessionmgr10&vid=1&hid=22&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ== Joshua, R., & Joshua, P. (2013). Investment banking : Valuation, leveraged buyouts, and mergers and acquisitions. (2nd ed., p. 44). wiley. Retrieved from http://reader.eblib.com.libproxy.utdallas.edu/(S(aljbqadjnoow44fgq4qurzsw))/Reader.aspx?p=12 04848&o=107&u=zuo8xoFLaLHtG8jPnubRqg==&t=1383971378&h=B0EC7CC551656C6B47 AFE0DBC59A44730D3F21AE&s=19581917&ut=244&pg=1&r=img&c=-1&pat=n Find a rating. (2012, 02 28). Retrieved from http://www.standardandpoors.com/ratings/en/us/ Research & rating. (2013, 09 03). Retrieved from https://www.moodys.com/creditratings/Starbucks-Corporation-credit-rating-600011184