Comparable Companies Analysis Overview

Introduction

• Comprehensive guide to Comparable Companies Analysis (CCA) in investment banking.
• Based on the textbook by Joshua Rosenbaum and Joshua Pearl.
• Recommended for anyone entering the investment banking industry or preparing for interviews.

Importance of Comparable Companies Analysis

• CCA is a primary method for valuing a target company.
• Establishes a market benchmark for valuation in various situations:
  • Mergers and Acquisitions (M&A)
  • Initial Public Offerings (IPOs)
  • Restructurings
  • Investment decisions
• Provides insight into relative positioning among peer companies.
• Effective in assessing current market conditions as compared to discounted cash flow analysis.

Steps in Comparable Companies Analysis

Step 1: Select Comparable Companies

• Identify a universe of comparable companies based on:
  • Business characteristics
  • Financial characteristics
• Due diligence is crucial:
  • Understand target company’s sector, products, customers, and geography.
  • Avoid overlooking sub-sector or significant differences in profiles.

Step 2: Locate Financial Information

• Gather financial data necessary for analysis from sources like:
  • 10-K and 10-Q reports
  • Proxy statements
  • Equity research reports
  • Bloomberg and Thompson Reuters.

Step 3: Spread Key Statistics and Ratios

• Calculate key financial statistics for each comparable:
  • Market Valuation Measures:
    • Enterprise Value (EV)
    • Equity Value
  • Income Statement Items:
    • EBITDA
    • Net Income
  • Focus on understanding these metrics for communication.

Step 4: Benchmark Comparable Companies

• Perform in-depth analysis to compare and rank comparable companies:
  • Assess relative strengths and weaknesses based on size, growth rates, margins, and leverage.
  • Experience is valuable for interpreting financial data effectively.

Step 5: Determine Valuation

• Use trading multiples of comparable companies to derive a valuation range for the target.
• Start with means and medians of relevant multiples for extrapolation.
• High and low multiples provide guidance on ceilings and floors for valuation.

Detailed Insights on Business and Financial Profiles

Business Profile Considerations

• Sector: Must identify specific sub-sector for proper comparisons.
• Products and Services: Differentiate between commodities and value-added goods.
• Customers: Understand common customer bases and their implications.
• End Markets: Distinguish between market categories served by the company.
• Distribution Channels: Different strategies affect operational performance.
• Geography: Regional economic differences can significantly impact valuations.

Financial Profile Considerations

• Size: Measure in terms of market valuation and financial statistics.
• Profitability: Analyze ability to convert sales into profits.
• Growth Profile: Historical and projected performance necessary for valuation.
• Return on Investment (ROI): Assess profitability concerning the capital invested.
• Credit Profile: Evaluate overall debt levels and creditworthiness.

Financial Statistics and Ratios in CCA

• Gather and calculate financial metrics:
  • Equity Value: Fully diluted shares outstanding x current share price.
  • Enterprise Value: Includes Equity Value, debt, preferred stock, non-controlling interest, minus cash.
  • EBITDA: A metric for operating cash flow, preferred by bankers.
• Leverage Ratios: Debt metrics, interest coverage ratios, etc.

Adjustments and Normalization

• Calendarization: Ensure data being compared is for the same time period.
• Adjust for Non-recurring Items: Important to reflect normal business operations.

Valuation Multiples

• Equity Value Multiples: Price to earnings (P/E) ratio.
• Enterprise Value Multiples: EV/EBITDA, EV/EBIT, and sector-specific multiples.
  • These multiples are preferred as they are capital structure independent.

Benchmarking and Final Valuation

• Benchmark financial statistics and trading multiples to rank relative to the target.
• Use trading multiples to derive an appropriate valuation range.
• Consider using forward-looking metrics for valuation ranges.

Advantages and Disadvantages of CCA

Advantages

• Based on market data reflecting current expectations.
• Convenient and quick relative to other methods.
• Easy to measure and understand.

Disadvantages

• Market biases may affect valuations during economic extremes.
• Difficult to find perfect comparables for analysis.
• Potential disconnect from actual cash flows and company-specific issues.

Conclusion

• CCA is a vital tool in an investment banker's toolkit.
• Important to combine CCA with other valuation methods for comprehensive analyses.