The precedent (or comparable) transactions method is part of the Market approach family of valuation methodologies, which compare the subject company to similar businesses, business ownership interests and securities (investments) that have been sold.
Through an analysis of precedent transactions, the value of a company is estimated by looking at the considerations paid in M&A deals concluded on the equity stakes of peer companies, expressed in terms of one or more transaction multiples (e.g. EV/EBITDA, P/BV, etc.), which are then applied to the subject company's relevant metric as at the valuation date.
Let's look at how to perform an effective and meaningful analysis on precedent transactions.
When to use the precedent transactions method
Precedent transactions are rarely directly comparable, as every transaction has its own unique set of circumstances. Furthermore, the transaction multiples typically yield a higher value range due to the fact that strategic premiums and synergies are factored into the consideration paid. For these reasons, transaction multiples are typically used as a cross-check methodology, to support and validate the valuation range resulting from the application of the primary valuation method, most commonly the DCF or another Income approach methodology.
How to perform a precedent transactions analysis
Never forget: 1 great transaction is worth more than 10 so-so ones. Choose quality over quantity, always.
Summarized below are the best market practices on how to execute a precedent transactions analysis:
Use Mergermarket to screen for transactions: this is the most popular source of information on precedent transactions used by financial advisors. Other commonly used sources include the Bloomberg terminal (function 'MA') and Zephyr (a Bureau van Dijk database).
When screening for transactions involving targets operating in the same business sector as your subject company, consider a historical period of 3 years from the valuation date. You may extend the time horizon to consider a historical period of 5-10 years if M&A activity in the specific sector has been particularly slow.
Screen for transactions that have been concluded within the selected time frame: do not consider deals that have solely been announced, as they may not necessarily reach the closing.
Screen for acquisitions of controlling equity stakes in the targets (>50%): if you are valuing a minority stake, you will later apply a minority discount to adjust the estimated pro-rata equity value.
The screening should focus on deals concluded in the domestic market of the subject company. Your search may be extended to include regional deals, if M&A activity in the specific sector of the domestic market has been slow. NB: if you are valuing a company headquartered in a developing country, you should avoid considering acquisitions of targets based in developed countries (and viceversa), for comparability purposes.
Exclude from your screening those transactions without a public deal value: the multiples will be unavailable.
After running your screening based on criteria including industry, geography, % stake acquired, deal value availability and time period, assess the comparability of each target to your subject company, in terms of products and services offered, size (e.g. revenue, total assets) and geographical presence (e.g. % revenue contribution by country/region), to name a few. The targets' corporate websites and annual reports provide most of the information you will need to perform this analysis.
While running your comparability analysis on the identified targets, assess whether the resulting transaction multiple will need to be adjusted by a size discount.
At times, the implied transaction multiples will not be available from the deal description downloaded from Mergermarket, because earnings or book metrics are missing. If the target has a high degree of comparability to the subject company, don't automatically dismiss the deal: run your own search on the target's financial reports published closest to the deal's closing date (but never after) to obtain the metrics required to calculate the desired implied transaction multiples.
Remember to always download the deal descriptions from Mergermarket on your computer for backup: you never know if and when you may need to refer to them again.
If you want to consider the average transaction multiples for your valuation, make sure to eliminate all outliers from the calculation of the mean. The average without extremes typically falls close to the median transaction multiple. Many teams prefer to use the median directly and, in so doing, eliminate a certain level of subjectivity entailed in selecting and removing outliers.
100% equity value
As a general rule:
Use Enterprise Value multiples (e.g. EV/Revenue, EV/EBITDA, EV/EBIT) to value non-financial institutions. The EV/EBITDA multiple is by far the most popular. The EV/Revenue multiple (considered when EBITDA is negative) is generally only accepted to value young companies and start ups.
Use Price multiples (e.g. P/BV, P/E) to value financial services firms, as applying these multiples results in the direct valuation of a subject company's equity.
If you are valuing a majority stake and the selected transactions represent acquisitions of controlling equity stakes in the targets (>50%):
Apply the estimated Enterprise Value transaction multiple to the appropriate metric to estimate the EV of your subject company, then adjust for net cash/(debt) and other assets/(liabilities) to arrive at the equity value for a 100% equity stake in the subject company.
Apply the estimated Price transaction multiple to the appropriate metric to estimate the equity value for a 100% equity stake in the subject company.
Run your valuation by applying the selected transaction multiple to the appropriate earnings or book metric as at the valuation date (last twelve months, or "LTM"). If financial projections are available, you may also run your valuation considering the future earnings expected by the management of the subject company: in this case, remember to present value the forecasted metric before applying your transaction multiple.
If you are valuing a minority stake and the selected transactions represent acquisitions of controlling equity stakes in the targets (>50%), adjust the resulting equity value by a minority discount to reflect the embedded lack of control implied by a minority stake.
When the target is listed, you will often find information on the premium paid by the buyer for acquiring a controlling stake in the target, expressed as a % premium over the target's share price:
1 day prior
1 week prior, and
1 month prior
to the deal announcement date. This information provides an indication on the range of control premiums paid by investors to acquire targets operating in a particular business sector during the time horizon considered in your analysis.
Alongside the precedent transactions analysis, advisors will typically perform the trading multiples analysis, which is also part of the Market approach family of valuation methods and involves the screening of listed comparable companies. Share prices, however, are based on transactions between minority shareholders, thus implying a discount for the embedded lack of control. In order to value a controlling stake in the subject company using the trading multiples analysis, apply the average control premium resulting from your precedent transactions analysis to the trading multiples.
We hope you found this article useful. Make sure to download our Excel model template:
Our template includes detailed instructions on how to populate the required fields to run a precedent transactions analysis.
Furthermore, the template also allows you to perform the valuation based on the management's forecasts (e.g. LFY+1 EBITDA, LFY+2 Revenues, LFY+3 Net profit).
For questions or clarifications, feel free to reach out. Thanks for reading, and good luck!