PYA Presents Adjusting Valuation Multiples at NACVA

Page 1October 25, 2013

NACVA Georgia State Chapter Meeting

Market Approach: Adjusting Valuation Multiples

October 25, 2013

William B. Hamilton, MBA, CVA



Agenda

IntroductionIntroduction

Adjusting for SizeAdjusting for Size

Adjusting for Growth and CSRAdjusting for Growth and CSR

ConclusionConclusion

Market Approach ResourcesMarket Approach Resources



Introduction

“Finkel is Einhorn, Einhorn is Finkel.”

- Ace Ventura

The income approach is the market approach,the market approach is the income approach.

A multiple of 5X is a capitalization rate of 20%,a capitalization rate of 20% is a multiple of 5X.



Introduction

Cap rateInverse of valuation multiple

5X EBITDA = “an EBITDA capitalization rate of 20%”



Introduction

PGC multiple = 8XConvert to cap rate = 12.5%Add size adjustment1 = 5.0%Add growth adjustment2 = 2.5%Subject company cap rate = 20.0%

Convert to multiple = 5X

1 Subject size premium less PGC size premium.2 PGC growth rate less subject growth rate.



Adjusting for Size



Adjusting for Size

• SBBI Deciles

• Duff & Phelps Portfolios • Duff & Phelps Regression Formulas



Adjusting for Size



Adjusting for Size



Adjusting for Size

Which Exhibits to use?

• D&P “A&B Exhibits” apply to equity

• D&P “C Exhibits” apply to invested capital

Most applications are “capital structure” neutral, i.e. MVIC to EBITDA



Adjusting for Size

HURN FCN CRAI NCI Subject

Size Adjustment

Total revenues 677,100,000$ 1,610,000,000$ 261,780,000$ 752,440,000$ 10,000,000$

Constant 0.15060 0.15060 0.15060 0.15060 0.15060

Slope (0.02097) (0.02097) (0.02097) (0.02097) (0.02097)

Size-adjusted ERP based on revenues 9.12% 8.34% 9.99% 9.03% 12.96%

Size Adjustment, Rounded 3.80% 4.60% 3.00% 3.90%



Adjusting for Growth or CSR



Adjusting for Growth

Optional adjustment. Some considerations:

• Can use DCF to compute 5-yr CAGR for Subject

• Blend with long-term growth rate

• Analyst 5-yr growth estimates available for many PGCs

• Blend with long-term growth rate (estimate)



Adjusting for Growth

HURN FCN CRAI NCI Subject

Growth Adjustment

Growth estimate (5 years) 14.37% 13.50% 12.00% 11.67% 6.50%

Long-term growth estimate 5.00% 5.00% 5.00% 5.00% 3.00%

Blended growth rate 6.99% 6.64% 6.74% 6.48% 4.42%

Growth Adjustment 2.60% 2.20% 2.30% 2.10%



Adjusting for CSR

Optional qualitative adjustment. Some good reasons include:

• Extreme customer concentration

• Aging equipment relative to industry

• Unfavorable local demographics

• Poor business mix

• Significantly lower margins



Putting it All Together



ConclusionHURN FCN CRAI NCI

Share price 58.13$ 40.26$ 18.43$ 16.98$

Shares outstanding 22,350,000 39,140,000 10,180,000 49,960,000

Estimated market value of equity 1,299,205,500$ 1,575,776,400$ 187,617,400$ 848,320,800$

Interest bearing debt 181,890,000$ 723,000,000$ 6,840,000$ 128,420,000

Market value of invested capital (MVIC) 1,481,095,500$ 2,298,776,400$ 194,457,400$ 976,740,800$

EBITDA 144,880,000$ 254,340,000$ 22,930,000$ 122,830,000$

Unadjusted MVIC to EBITDA multiple 10.22 9.04 8.48 7.95

EBITDA capitalization rate 9.78% 11.06% 11.79% 12.58%

Add: Size adjustment 3.80% 4.60% 3.00% 3.90%

Add: Growth adjustment 2.60% 2.20% 2.30% 2.10%

Add: Company-specific adjustment 2.00% 2.00% 2.00% 2.00%Adjusted EBITDA capitalization rate 18.18% 19.86% 19.09% 20.58%

Adjusted MVIC to EBITDA multiple 5.50 5.03 5.24 4.86

Subject base year EBITDA 1,000,000$ Average adjusted EBITDA multiple 5.16

Indicated value of invested capital 5,160,000$

Rounded 5,160,000$



Conclusion

Income Approach

• Uses returns of entire stock market as foundation

• Adjust for size• Adjust for growth• Adjust for qualitative

risk factors

Market Approach(

• Uses industry cap rates set by market as foundation

• Adjust for size• Adjust for growth• Adjust for qualitative

risk factors

Two methods of estimating the cost of capital;

The only difference is the foundation.



ConclusionThere are practical differences between Income & Market Approaches:

1. The equity risk premium is calculated based on a different set of empirical data

2. Results can be skewed due to uneven growth rates

3. Market multiples are usually expressed in terms of EBITDA, which is used as a proxy for free cash flow

4. Capex/WC needs as a % of EBITDA should be monitored

5. Getting to “clean” EBITDA figure for PGCs can be tricky

6. Some PGC’s may have advantageous tax situations, increasing EBITDA to FCF conversion



Market Approach Resources



Market Approach ResourcesPGC Method

• Capital IQ• FetchXL and iMetrix• PitchBook• Yahoo! Finance, MarketWatch, Finviz, GuruFocus• Others?

M&A Method• Pratt’s Stats• BizComps• IBA Database• Pitchbook• Industry Specific: Irving Levin, Moss Adams, etc.• Others?



Contact Information

William B. Hamilton, MBA, CVAConsulting Manager(404) 266-9876

[email protected]

mailto:[email protected]

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PYA Presents Adjusting Valuation Multiples at NACVA