Mergers and acquisitions can be a complicated process. In order to fully understand the issues, a firm needs to keep abreast on the latest trends and legal news in relation to this field. But this task can be cumbersome and exhausting, which is where Comparable analysis comes into play. Comparable Analysis helps M&A advisors figure out what company could buy what company and why it would make sense for either party involved. It involves the calculation and analysis of various ratios and metrics like Market Capitalization, Employee size etc. to arrive at an investment decision.
A comparable company analysis (CCA) is a type of financial analysis in which you compare the financials of your company, that you are thinking of acquiring, to other companies in the same industry. The purpose of this analysis is to determine what the effect of an acquisition will be on the acquiring company’s future performance. You can also use these financial ratios to compare different companies that are in an industry and see how they stack up against each other.
According to Fintalent’s Comparable Analysis Consultants, many decisions made in a business will revolve around the potential for synergy due to the acquisition of assets or companies. This can be seen as when businesses combine operations or when one company takes over another, and this is the case with mergers and acquisitions (M&A). In order to evaluate whether an M&A decision would help a company’s bottom line, they have to analyze how they will fare through comparison against competitors in making their decision. In other words, it is important to have comparable analysis in M&A situations because it gives an accurate assessment on what may happen next.
Acquiring a company involves making a decision whether to acquire and how much to acquire the company. The most important utility for any business is to know if the necessary resources will be available for the acquisition, how much it will cost, and whether it is worth the investment. However, when an M&A situation crosses over into other businesses and becomes an M&A decision, it can be challenging to compare a company’s performance with competitors that do not own the assets of an acquired firm.
The initial reaction in the case of a merger is for assets to be viewed as complements in value and thus work together to improve the bottom line of a business. In some cases, there will be a significant loss or gain depending on how this is calculated. The difference between the value of the assets before and after the merger will be assessed using a multiple:
For example, if Company A takes over Company B and pays 5 times book value for it, it would pay $5*BV for each share of Company B.
Therefore, if A’s book value and the multiple is used to calculate A’s value added, as BV*(1+A multiple), then the company could expect that it will increase by BV. If it stays same or even becomes negative, then this may not be a good deal for the acquiring company.
There are two main cases to consider when using competitive effects to assess how strong a merger or acquisition may be as it compares with competitors in the market:
If there is high competition and close substitutes, then companies should start considering how they can improve their business operations to compete with other firms. This would include trying to lower costs, increase production capabilities, and improve marketing of its products so that customers will receive better benefits from their purchases. If a product has multiple benefits as opposed to one benefit, it is advantageous to have the business operate efficiently and allocate resources on what they can do best, improving the company’s future performance.
If there is low competition and few substitutes, then companies should attempt to differentiate their products by providing unique benefits that customers want to purchase so that profits are higher than in previous years. For example, it may be better for a company to purchase another company because its products offer benefits over other competing items in the market.
Applying these two factors above allows companies and their employees to be able to make more informed decisions on how big an acquisition will be beneficial for their business long-term.
When completing a comparable analysis in M&A, it is important to look at the relevant industrial factors that drive profitability. These are the factors that will help determine whether an acquisition will improve the finances of any one company, as well as assess how strong an acquisition will affect competitors in the same industry.
There are six general metrics that can be used to gauge the performance of a company:
Price: This is most commonly used measure in valuing market capitalization of publicly traded companies. Price per share is obtained by dividing stock price by number of outstanding shares. For example, if a company has 100 million shares outstanding and is selling for $100 per share, the stock price would be $10 billion. Non-GAAP EPS: This is the most commonly used industry metric that compares a company’s earnings before interest, taxes, depreciation and amortization (EBITDA). This metric helps compare operating profits using adjusted items and other non-operating expenses to determine overall financial performance. For example, if a company had an EBITDA of $4 million in the recent year but averaged EPS at only $2 million the year before (not including any D&A), then there would be a negative EBITDA multiple of -2.33. This would mean that the company was earning $3.33 per share when it had an EBITDA of $4 million. Margin: A margin is the percentage of net income allocated to each operating segment in a company’s accounts payable, operating income, change in operating assets and liabilities, and cash flow statement. For example, if a company has two sections in its income statement and one section had the following profit:
Subsidiary B: Income from operations $600,000
Subsidiary C: Income from operations $400,000
The total profits from both subsidiaries would be under the total profit for a parent company by $200,000 for that year. The company’s overall profit/margin is 1 billion, which equals 20% of the company net income for that year. Turnover: This is the ratio between sales and total assets in a business. This is usually referred to as asset turnover and can be computed by dividing sales by average total assets:
Total Assets = $15 billion
Sales $2 billion
Therefore, the turnover would be .1347 ($2 billion/$15 billion). In this case, it shows that the company turns over its assets in 13.47 times a year, or every 8 weeks. Asset size companies typically have high turnover because of high volume of sales, while low turnover is more common among stable businesses with consistent asset value (e.g. an office building).
Employee size: This factor quantifies the relationship between a company’s sales revenue and its employee count. This is most commonly referred to as employee productivity, which can be computed by dividing net profits by number of employees.
For example, if a company had $100 million in net profits and 4000 employees:
Net Profits = $100 million
Employees = 4000
Full-time equivalent (FTE) Employees = 4000 ÷ 52 = 8.09 FTE Employees
Thus, the ratio of employees to net profit would be equal to 8.09. Low employee counts and a high ratio means that profits are generated from few employees, while higher employee counts and a low ratio means that employee productivity is not very high.
Market capitalization: Market capitalization is the overall value of a company. It is commonly measured in terms of shares outstanding multiplied by price per share. This figure shows how much investors believe the company to be worth. The higher the market capitalization, the more valuable an asset should be to an acquirer because it will be more expensive to acquire it due to its high price per shareholder’s equity or stockholder’s equity.
Market Capitalization = (Number of Shares Outstanding) × (Price per Share)
A company’s total number of shares outstanding may be in the millions or billions. For example, General Motors has a market capitalization of $35 billion, which is based on a stock price of $21 per share. This value corresponds to a market cap of about 16,805 billion shares.
Sale price – purchase price: This is the amount an acquirer pays for an acquired firm and its assets in order to purchase the firm’s assets and control its operations. The sale price includes all cash paid by the acquirer; any assumed liabilities; and any assumption options that were granted by shareholders prior to the acquisition date. This is a very important category in determining the value of the company, because it is a good place to compare. Purchasing firms are in a better position to determine their target price because they have all the information necessary to make an intelligent decision on what they will pay. It is important to note that the sale price varies significantly depending on individual circumstances and market conditions.
For example, if John Smith sells his company for $100 million and receives $100 million cash payment as well as options that grant him 1% of net profits each year over 10 years then his value will be:
In this case, John Smith’s total value from sale will be $1 million according to his assumption option award during the acquisition period.
Cash equity: This is the total dollar amount of cash and non-cash assets (e.g., equipment, furniture and fixtures) that are added to an existing business in exchange for all its equity. To calculate this figure, it is necessary to determine the total value of all existing assets which must be purchased in order to acquire a business’ assets and operations. It does not include noncash expenses like compensation or capitalized lease payments for real estate.
Value for shareholders: This is the total dollar amount of cash and non-cash assets (e.g., equipment, furniture and fixtures) that are added to an existing business in exchange for all its equity. To calculate this figure, it is necessary to determine the total value of all existing assets which must be purchased in order to acquire a business’ assets and operations. It does not include noncash expenses like compensation or capitalized lease payments for real estate.
Asset purchase price: This represents the total dollar amount paid by an acquirer to acquire a business’ assets and operations. The asset purchase price includes cash paid for assumption of liabilities, and assumption of board options (if any). It does not include noncash expenses like compensation or capitalized lease payments for real estate. It does not include interest paid on assumed liabilities given by the acquirer on financing arrangements. In calculating this figure, it is necessary to determine all costs associated with operating a business (e.g., sales and marketing, labor, fixed asset depreciation, taxes, cash). This includes any costs which must be paid for by the acquirer to acquire a business’ assets and operations.
Other significant metrics include:
Operating purchase price: This is the total amount that an acquirer pays for the firm’s operating business (i.e., market capitalization less sale and asset purchase prices). The operating purchase price represents the total value of the firm’s operating assets less interest earned on any assumed liabilities.
It does not include cash paid for assumption of liabilities, or assumption of company management options.
Implied multiplier: This is a ratio which indicates how many times an acquirer will pay for the acquired company’s business. It is calculated by dividing market capitalization plus asset purchase price by operating purchase price. The implied multiplier indicates how much an acquirer should be willing to pay in order to take over an acquired business’ assets and operations. The higher the implied multiplier, the more expensive it should be to purchase operations compared with market capitalizations and asset prices (i.e. the less “cheap” the business is). This is because the acquirer pays a higher implied multiplier to gain control of a firm’s assets than it pays for the company’s market capitalization.
Inventory value: This is the total dollar value of all inventory in a business. It includes all inventories and non-inventory items that have some kind of physical existence. For example, the inventory value of a grocery store would include items such as canned and bottled drinks; bottled water; meat and produce; ramen and cereal; cleaning supplies; etc. It does not include intangible items like books and videos; staples such as office supplies; or used equipment items.
Inventory turnover is a key factor in computing inventory value, because it indicates how many times an acquired firm turns over its inventory in one year. The higher the turnover, the more it sells (or turns over); therefore, the more products it must store to meet demand (i.e. inventory).
Trade receivables value: This is the total dollar value of all accounts receivable which are owed to a business by its vendors and customers. It represents the amount that is owed to a firm from accounts which have not yet been paid. Trade receivables value is generally expressed as a percentage of sales.
Trade allowance value: It is the total dollar amounts of payments made by an acquirer based on allowances (i.e., discounts) that are granted to customers and vendors in order to generate sales. It includes trade discounts, cash discounts, shipping and handling charges, and cash-with-order discounts. It represents all payment remittances given to customers or vendors based on any type of allowance or discount granted prior to the acquisition date of the acquired business.
Accounts payable value: This is the total dollar amount of accounts payable that are owed to a firm by its customers. It represents the amount that is owed to a business from accounts which have not yet been paid. Accounts payable value is generally expressed as a percentage of sales.
Accounts receivable value: This is the total dollar amount of accounts receivable that are owned by a business from its customers. It represents the amount that is owed to a firm from accounts which have not been paid. Accounts receivable value is generally expressed as a percentage of sales.
Interest expense: This represents the total dollar amount of interest paid by an acquirer in acquiring a business. The interest expense is paid to purchase a firm’s assets and operations. To calculate this figure, it is necessary to determine the interest earned on any assumed liabilities and subtract that from the total cash investment for assets. It does not include cash paid for assumption of executive options or cash payments made for assumed liabilities.
Pre-tax income: This represents the total dollar amount of pre-tax income that a firm generates every year due to its operations (i.e., after all expenses are paid). Pre-tax income does not include any tax deduction.
Tax expense: This represents the total dollar amount of taxes paid by an acquirer in acquiring a business. The tax expense is paid to purchase a firm’s assets and operations. To calculate this figure, it is necessary to determine the total income to be taxed by the acquirer and then subtract that from the total cash investment for assets. It does not include cash payments made for assumed liabilities.
Net income: This represents the dollar amount of pure profit generated by a business each year (i.e., after all expenses are paid). It is calculated by subtracting the total tax expense from pre-tax income. It does not include any tax deductions, or any interest earned on any assumed liabilities.
Equity: This represents the total dollar value of a business’ equity prior to an acquisition. Equity can be divided into two components: common stock and retained earnings. Common stock represents the value of a share in a company (i.e., the net worth that is split between all equity holders). Retained earnings represent the cumulative value of earnings which have been retained by an acquirer, instead of being paid out to shareholders as dividends.
Risk: This represents the total dollar amount of risk that a business bears in the form of competition, regulatory sanctions, its own products failing to meet market requirements, or other factors (e.g., obsolescence).
Cash acquisition price: This represents the total dollar amount paid by the acquirer to acquire a business. It is calculated by adding all the costs incurred in acquiring a firm’s assets and operations (e.g., purchase price of tangible assets, assumed liabilities and option payments if any), plus cash paid for assumption of debt obligations or other restricted payment obligations (if any). It does not include non-cash expenses like compensation or capitalized lease payments for real estate. It does not include interest paid on assumed liabilities given by the acquirer on financing arrangements. It represents the total amount of cash that a firm will have to pay in order to acquire a business.
Contributed capital: This is the total dollar value of capital contributed by all equity holders of an acquired firm. It represents the amount that is contributed per share by all corporate shareholders. This includes both common stock and retained earnings. The term “contributed capital” overlaps with its financial statement counterpart, Retained Earnings; however, it can be distinguished by retaining separate historical records of acquisitions that occurred in its operations (i.e., retained earnings).
Initial investment: This shows the cash amount of cash and noncash assets (e.g., equipment, furniture and fixtures) that are added to an existing business in exchange for all its equity. To calculate this figure, it is necessary to determine the total value of all existing assets which must be purchased in order to acquire a business’ assets and operations. It does not include noncash expenses like compensation or capitalized lease payments for real estate. Total Initial Investment cannot be greater than the value of Assumed Liabilities or Cash Acquired as part of the acquisition along with any additional investment by a sponsor in common stock or retained earnings.
Initial equity: This shows the dollar amount of capital contributed by all shareholders in acquiring a business. It represents the amount that is contributed per share by all corporate shareholders. This includes both common stock and retained earnings. The term “Initial Equity” overlaps with its financial statement counterpart, Contributed Capital; however, it can be distinguished by retaining separate historical records of acquisitions that occurred in its operations (i.e., retained earnings).