Relative Valuation Methodologies

Valuing any object, asset or company and putting the right price to it is the trickiest situation in any
Mergers and Acquisition transaction. There are many valuation techniques which are used by
Investment Bankers, Corporate Finance Analysts, Stock Brokers and many others. Now comes
second question, which is the best technique for valuing your company.

There are basically two approaches which are used industry wise: Relative Valuation and Intrinsic
Valuation. Relative valuation approach operates through valuing a company based on current market
price of similar companies or similar transactions. This approach includes methodologies like
Transaction Comparable and Trading Comparable. On other hand, Intrinsic valuation approach tries
to determine the true value of the asset based on its capability to generate future returns. Primary
methodology used for calculating intrinsic value is Discounted Cash Flow.

Let us try and understand the Relative Valuation in detail, before we go in details of DCF.

 Trading Comparable: In this approach, the value of similar publicly traded companies is used
as the benchmark to determine the value of our interest. Let me help you understand
through a real-life example. Even when we go to buy as simple as mangoes, we have to rely
upon the price quoted by shopkeeper. But, if know the price which is currently prevalent in
the market and other sellers are asking then it makes our purchasing easy.
Similarly, if we know the market valuation of companies which are like us then we can easily
get the idea about the price of our company.

Steps of value determination

a. Determining Peer set: First and foremost, step is determining companies which are
into similar business and can be used as comparable companies to our company.
Straightforward way to determine peer set is to consider the competitors of our
company.
b. Collecting Market data: Collect market data about the peer companies using sources
like stock exchanges, SEC filings, Annual reports and other financial databases.
Market data required for our analysis will latest available data including Market
Capitalization (MCap), Total Debt (D), Cash and Cash Equivalents (C), Minority
Interest (MI), Full year Revenue (Rev), Full year Earnings Before Interest, Tax,
Depreciation and Amortization (EBITDA) and Full year Net Profit (NPAT)
c. Calculating Valuation Multiples: EV/Revenue, EV/EBITDA and Price to Earnings are
three industry wide used valuation multiples. These three covers the most important
aspects of any business: Top line, operating margins and finally money that any
business earns. So, using these three parameters together will help us averaging out
any business specific anomalies.
i. Enterprise Value (EV): MCap + D – C + MI
ii. EV/Revenue: EV to Rev ratio
iii. EV/EBITDA: EV to EBITDA ratio
iv. Price to Earnings (P/E): MCap to NPAT ratio
d. Determining value of Target: Using above calculated three ratios, we will get three
numbers for value of our target
i. EV/Rev ratio: Multiply EV/Rev ratio with latest full year Revenue of our Target
 ii. EV/EBITDA ratio: Multiply EV/EBITDA ratio with latest full year EBITDA of our
Target
iii. P/E ratio: Multiply P/E ratio with latest full year NPAT of our Target and then
Add Net Debt (D-C) of Target and Add MI of Target

Above calculated three different Enterprise Values will give you range of the value that
market is giving to your business. Even if our Target is publicly traded then also, these trading
comparable valuations will remove any company specific anomalies and give us widely
accepted market price for business like our Target.

I have captured the methodology in an excel template. Please download the file from below
link:
https://drive.google.com/file/d/0B8GwA2wLuBigTTR1YmRNT1FpbDg/view?usp=sharing

 Transaction Comparable: In this approach, the value of similar transactions which happen in
recent past are used as benchmark to determine value of our Target. Let me help you
understand through a real-life example. When you go to buy a house, and seller quotes you
some price. How you generally determine what should be the correct price? You enquire or
collect information regarding the price which was paid to previous sellers in the same
locality. This means you draw your conclusion based upon the transactions which happened
in the same society and in the same timeframe.
Similarly, Transaction Comparable approach uses the precedent transaction of similar
companies and value paid to them to determine value of our Target.

Steps of value determination

a. Selecting Precedent Transactions set: First and foremost, step is determining

transactions which happened in the recent past into similar sector/space in which our
Target operates. Upfront way to determine precedent transactions is to see if any of
our competitors’ have sold their company. Also, if they have bought some company,
then if that company is into similar sphere in which our Target operates.
b. Collecting Market data: Collect deal related data regarding above selected
transactions using sources like Press releases, Annual reports, Stock exchange
fillings, Analyst coverage and other financial data bases. Market data required for our
analysis is Deal Value (DV), Transaction Target’s Net Debt (ND = Debt - Cash) and
Minority Interest (MI), Transaction Target’s Full year revenue (Rev), Transaction
Target’s Full year EBITDA (EBITDA), Transaction Target’s Full year NPAT (NPAT).
c. Calculating Valuation Multiples: EV/Revenue, EV/EBITDA and Price to Earnings are
three industry wide used valuation multiples. These three covers the most important
aspects of any business: Top line, operating margins and finally money that any
business earns. So, using these three parameters together will help us averaging out
any business specific anomalies.
i. Enterprise Value (EV): It depends if the acquisition is a majority acquisition or
minority acquisition. If stake acquired is more than 50% then Deal value is
same as EV. But, if stake acquired is less than 50% then EV needs to be
calculated: Deal value * (100% / % stake acquired) + ND + MI
ii. EV/Revenue: EV to Rev ratio
 iii. EV/EBITDA: EV to EBITDA ratio
iv. Price to Earnings (P/E): Equity Value (EV – ND – MI) to NPAT ratio
d. Determining value of Target: Using above calculated three ratios, we will get three
numbers for value of our target
i. EV/Rev ratio: Multiply EV/Rev ratio with latest full year Revenue of our Target
ii. EV/EBITDA ratio: Multiply EV/EBITDA ratio with latest full year EBITDA of our
Target
iii. P/E ratio: Multiply P/E ratio with latest full year NPAT of our Target and then
Add Net Debt (D-C) of Target and Add MI of Target

Above calculated three different Enterprise Values will give you range of the value that are
currently Transactions are getting paid for similar line of business. However, there is a
possibility that you will not be able to collect all the market data about transactions which
involve private companies. In that case try calculating the valuation ratios which you can and
use a list of precedent transactions for deriving the values.

I have captured the methodology in an excel template. Please download the file from below
link:
https://drive.google.com/file/d/0B8GwA2wLuBigTTR1YmRNT1FpbDg/view?usp=sharing

For detailed understanding of DCF methodology, please click below link: