4. Choosing Valuation Situations

The third potential challenge results from the fact that we need to observe actual prices paid in order to compute valuation multiples. Put differently we need to observe situations where buyers and sellers meet and agree on a price. In this section, we discuss the different types of multiples that are typically available, the relevance of the (implicit) assumptions we make about control, liquidity, and synergy when using these multiples, and how to use multiples to value different strategic alternatives.

 

Different Types of Multiples

Generally speaking, there are two typical valuation situations that allow us to compute multiples: Stock prices we observe on the stock market and prices we observe from corporate transactions (e.g., mergers and acquisitions). The resulting valuation multiples we can compute are the so-called trading multiples and transaction multiples, respectively.

  • Trading multiples: Trading multiples are based on the valuation of firms that are traded on a stock exchange. We have already encountered trading multiples before, for example in the valuation of Ford Motors using P/E ratios. Trading multiples reflect the current stock market valuation of a company, i.e., the price at which individual shareholders are willing to buy and sell shares.
  • Transaction multiples: Transaction multiples are based on the valuation of recent corporate transactions such as mergers and acquisitions, leveraged buyouts, etc. We have also used transaction multiples already, for example in the introductory example of Heineken's acquisition of Femsa's beer business at a valuation of an EV/EBITDA ratio of 11. 
    • Depending on the type of acquirer, we distinguish between strategic and financial deals. Strategic deals often aim at generating synergies from combining the businesses of the buyer and seller. The above example of Heineken was a strategic deal. In contrast, a financial deal often "just" entails the transfer of ownership without too many implications for the firm's business model. Strategic buyers are often competitors, suppliers, customers, or firms that want to enter a specific market (segment). Financial buyers could be private equity funds or public shareholders.
    • Moreover, depending on the size of the acquired position, we distinguish between full-firm acquisitions and minority acquisitions. In a full-firm acquisition, the acquire buys a controlling stake in the company (>50%, typically 100%). Again, Heineken was an example of a full-firm acquisition. In contrast, a minority acquisition entails an ownership stake of less than 50%. This implies that the buyer then generally does not control the target firm.

 

It is important to understand the different types of valuation multiples because the underlying valuation situations can be fundamentally different in terms of the control, liquidity, and synergy that are associated with the deal. This is the next topic.