Comparable Companies Analysis Lecture Notes

Introduction

• Topic: Comparable Companies Analysis (Comps)
• Purpose: To provide a comprehensive overview of the methodology for valuing a target company through comparison with similar companies.
• Recommended resource: "Investment Banking: Valuation, Leveraged Buyouts and Mergers & Acquisitions" by Joshua Rosenbaum and Joshua Pearl.

Overview of Comparable Companies Analysis

• Definition: A primary methodology for valuing a target company by establishing a market benchmark based on similar companies.
• Use Cases: Mergers, acquisitions, IPOs, restructurings, investment decisions.
• Importance: Reflects current market conditions and can sometimes be more relevant than discounted cash flow (DCF) analysis.

Methodology Steps

1. Select Universe of Comparable Companies
   • Identify companies that share key business and financial characteristics with the target.
2. Locate Financial Information
   • Gather necessary financial data for analysis.
3. Spread Key Statistics and Trading Multiples
   • Calculate market valuation measures (e.g., Enterprise Value, Equity Value).
4. Benchmark Comparable Companies
   • Examine similarities and discrepancies among comparables.
5. Determine Relevant Valuation
   • Use trading multiples to establish a valuation range for the target.

Step 1: Selecting Comparable Companies

• Key Considerations:
  • Business Profile: Sub-sector, products/services, customers, end markets, distribution channels, geography.
  • Financial Profile: Size, profitability, growth profile, return on investment, credit profile.
• Methodology: Conduct thorough due diligence on the target company before identifying comparables.

Step 2: Locating Financial Information

• Sources:
  • 10-K and 10-Q reports
  • Proxy statements
  • Equity research reports
  • Financial databases (e.g., Bloomberg, Thomson Reuters).

Step 3: Spreading Key Statistics and Trading Multiples

• Financial Metrics:
  • Size Metrics: Equity Value, Enterprise Value, Sales, Gross Profit.
  • Profitability Metrics: EBITDA, Net Income.
  • Growth Metrics: Historical and estimated growth rates, ROI.
  • Credit Metrics: Leverage ratios, coverage ratios, credit ratings.

Step 4: Benchmarking Comparable Companies

• Analysis: Compare financial statistics and trading multiples among the selected companies to determine relative rankings.
• Objective: Frame the valuation based on strengths and weaknesses of the target company compared to its peers.

Step 5: Determining Valuation

• Valuation Basis: Use trading multiples of comparable companies to derive an appropriate valuation range for the target company.
• Process:
  • Calculate means and medians of relevant multiples.
  • Establish a defensible range for valuation.

Advantages of Comparable Companies Analysis

• Utilizes market-based information reflecting real market conditions.
• Quick and straightforward to measure and compare.
• Current data can be updated frequently.

Disadvantages of Comparable Companies Analysis

• Market conditions may distort valuations (bias in boom/bust cycles).
• Finding truly comparable companies can be challenging.
• Potential disconnect from cash flows; market sentiment may not reflect true value.
• Company-specific issues can influence valuations.

Conclusion

• Comparable Companies Analysis is a critical tool in an investment banker’s toolkit for valuing companies.
• It should be used in conjunction with other methodologies (e.g., DCF analysis) to provide a comprehensive valuation perspective.