Precedent Transactions Analysis (PTA) is one of three valuation methods often used by investment banking analysts to estimate a company’s value: DCF analysis, comparable company analysis, and precedent transactions analysis. Precedent transactions analysis is a pretty simple tool to give you a baseline of what the valuation should be, but more intricate analysis methods are needed in situations that require more accuracy. However, that does not mean Precedent Transactions Analysis is not important. In fact, Precedent Transactions Analysis can even be more helpful in certain situations, for example, when evaluating market demand for acquiring a company in a certain industry. This article will help you conceptually understand this method and give you a step-by-step walkthrough on how to value a company using Precedent Transactions Analysis.
So what is precedent transactions analysis? Precedent Transactions Analysis, also called “M&A Comps” or “Comparable Transactions,” uses the prices paid for comparable companies in the past to gauge the valuation of the current transaction. It also gives an estimate of the implied stock price in case of an acquisition. However, remember that it yields the acquisition price of the business at the time the transaction is completed, rather than today.
Unlike comparable companies analysis (comps) that uses the traded market values of the company’s securities, PTA uses the price paid by the purchaser for a business as the basis for valuation. Therefore, PTA often takes into account the control premium (the value associated with controlling the business rather than controlling a proportion of equity), and yields a higher valuation than other methods.
With so many flaws and limitations, why do we bother to use precedent transactions analysis? There are several reasons why PTA is sometimes more preferred than other methods.
- To value a private business that does not have public trading comparables
- To gauge the market demand for a certain type of industry
- To identify potential bidders for acquired companies
- To identify potential sellers if a company is looking out to acquire another company.
- Does not require confidential information
- Ensure plausibility: these transactions are successfully completed at certain valuation levels
- Give information about potential bidders and sellers
- Shows market trends
Public data can be incorrect
Market conditions of past transactions can be significantly different from the current transaction’s market conditions
Difficulties in finding truly comparable transactions
The model tends to overvalue
3. How to Perform Precedent Transactions Analysis?
3.1. Select Comparable Transactions
This step is usually the hardest part of the analysis. In the universe of transactions, it is more than difficult to single out 4 to 5 comparable transactions for the analysis. In addition, there are countless sources of public information, and not all of them are reliable. We recommend that you use databases directly disclosed by the company, such as a merger proxy statement. SEC’s documents are also similar in quality. Equally valuable are equity research reports or financial databases like Capital IQ and Factset. However, remember that the more indirectly the information is disclosed, the more likely you need to verify the information before building the model.
In selecting the appropriate transactions for your analysis, it is important to take into account these important factors:
- Same business & industry
- Similar business size
- Similar sales growth rates and profitability margins
- Similar capital structure
- Similar reasons for transaction (e.g. fire sale, bankruptcy, or strategic motive).
- Same geographic location of operations
For publicly traded target:
- Merger Proxy: a SEC filing required when a public companies do something that must be voted on by shareholders
- Tender offer documents: the documents containing the terms and conditions of the Offer sent to the holders of the target companies
For publicly traded acquirer but private target:
- 8-K: a report of corporate changes at a company that could be important for its shareholders or SEC
- Annual reports and 10-KL: a comprehensive report required by SEC filed annually by a public company about its financial performance
Where can we find transaction-specific information for our analysis?
3.2. Identify Relevant Information for the Analysis
The key information to be looked into include:
- Announcement/Closing date of the transactions
- Bidder: Acquirer
- Target: Acquiree
- Business Description of the target company
- Local currency: the currency in which the transaction took place
- Acquired Stake: the percentage of the target being acquired
- Consideration type (cash or stock)
- Net debt acquired: the net debt of the target company being acquired
- Implied equity value: equity consideration to be paid by bidder
- Grossed-up equity value: the adjusted equity value when the acquired stake is less than 100%
- Implied enterprise value: grossed-up equity value plus net debt acquired
3.3. Calculate Implied Equity and Enterprise Value
When a company is bought, the purchase agreement in-the-money dilutive securities get cashed out or get converted into an equivalent number of the buyer’s securities. Either of those scenarios would cost the buyer something when it acquires the company in question. Equity value is like the sticker price saying how much it costs to buy the company. However, there are additional items that can push up or push down the effective price afterwards, so the actual cost of buying that company might be different from the sticker price. This actual price is the enterprise value.
Depending on the acquired stakes and other stipulations in the purchase agreement, ways of valuing a company might vary. In the case that the acquirers buy up 100% of the target company, equity value is the equity consideration to be paid by the bidder. In the case that the acquirers only buy parts of the company, the equity needs to be grossed up to account for 100% of the target company’s value. For example, if company A gives the company B $1 million for 50% of their company, the equity value of company B is $2 million. Enterprise value is calculated using this formula:
Enterprise Value = Equity Value + Debt + Preferred Stock + Noncontrolling Interests – Cash & Cash-Equivalents
3.4. Calculate Precedent Transactions Multiples
You will generally use a Revenue multiple (Enterprise value / Revenue), which measures how valuable a firm is relative to its net sales. Another alternative to revenue multiple is profitability multiple (P/E, EV/EBITDA, EV/EBIT, EV/Unlevered FCF, or Equity Value/Levered FCF), all of which measures the value of a company relative to different metrics of profitability.
|Multiple names||What it means?||When to use?|
|Enterprise Value/EBIT||Measure how valuable a company is relative to its income from operations||Especially used for companies whose CapEx is important to factor in the valuation|
|Enterprise Value/EBITDA||Measure how valuable a company is relative to its operational cash flow||Especially used for companies whose CapEx and D&A are not important to the valuation|
|P/E||Measure how valuable a company is relative to its earnings after tax||Most relevant for banks and other financial institutions|
|Equity Value/Levered FC||Measure the equity value of a company relative to its true cash flow||Not common and may produce wide-ranging results to due different capital structure|
|Equity Value/Unlevered FC||Measure how valuable a company is relative to its unlevered cash flow||Capital structure-neutral, so it is better for comparing different companies. Used when CapEx or Deferred Revenue have a big impact|
3.5. Apply the Multiples to Arrive at Valuation Range for the Company
Having had a range of multiples in the previous step, we will apply them to the financials of the company we are valuing in order to arrive at its implied enterprise value. For example, if the range for the EV/EBITDA multiple is 1x–5x, and the EBITDA of the company in question is $100 million. Then, the valuation range for their business would be:
- Low: $100 million
- High: $500 million
3.6. Conduct Price Premium Analysis Overview
Control premium is the premium that an acquirer is willing to pay to gain control of the target company. For example, if company B is buying company A for $200 per share while the market value of company A’s share is $150, company B is paying a premium of $50 for the acquisition of company A.
Control premium needs to be calculated to approximate the offer price premium for a target company. The premium is typically calculated using the following formula:
Premium Paid (%) = (Acquisition Price ÷ Last Trading Price – 1) × 100
4. Precedent Transactions Analysis and Other Valuation Methods
|Discounted Cash Flow Analysis||Comparable Companies Analysis||Precedent Transactions Analysis|
|Other names||Intrinsic Value Model||Trading Multiples, Peer Group Analysis||Comparable Transactions, M&A Comps|
|Approach||Intrinsic Approach||Relative Approach||Relative Approach|
|How does it work?||Analysts forecast the business’ free cash flow into the future and discounts it back to today at the firm’s Weighted Average Cost of Capital||Analysts compare the current value of a business to other similar businesses by looking at trading multiples like P/E, EV/EBITDA, or other ratios||Analysts compare the company in question to other businesses that have recently been sold or acquired in the same industry.|
|Valuation Metrics||Dividends, cash flow, and the growth rate for a single company||Multiples of similar companies||Multiples of similar transactions|
|When to use?||Lots of certainties in the future performance of the company/industry; Financials are transparent.||If no financial data is available; if there are significant uncertainties in the future operations of the business/industry outlook.||If no financial data is available; need to identify potential bidders and sellers|