Notional valuations may use public equity market multiples to assist in establishing the value of a subject company. A public company multiples approach involves an analysis of multiples based on the publicly traded equity prices of a comparable company (or companies). Such an analysis should seek to identify comparable companies that operate in a similar line of business to the subject company and actively trade on the open market. There are several key considerations to be made when selecting companies that are comparable, such as:

  • Company Size
  • Nature of the Products or Services Offered
  • Degree of Vertical Integration
  • Geographic Coverage and Market Characteristics
  • Level of Net Tangible Assets and Sustaining Capital
  • Profitability and Operating Measurements
  • Historical Growth in Earnings or Cash Flow
  • Strategic Direction and Focus

No two companies are exactly comparable. A thorough analysis of public market multiples must consider appropriate adjustments for the fundamental differences between the selected comparable publicly held companies and the subject company, including the following:

  • Premiums for Control and Market Perceived Synergies
  • One-Time Capital Expenditures and/or Working Capital Adjustments
  • Significant Litigation Claims and/or Awards
  • Environmental Obligations and other Contingencies
  • Redundant Assets
  • Illiquidity and Blockage
  • Implication of Income Taxes, Tax Credits, and the Present Value of Loss Carry-Forwards

While a public company analysis can provide a useful reference, it is important to understand the limitations of using public equity market multiples to value a subject company. Some of the key limitations may include:

Size

Public companies are often much larger, allowing them greater management depth, customer diversification and market presence.

Management

Management teams of public companies focus strongly on accounting earnings due to their impact on the share price whereas private company managers tend to focus on cash flow with a mind to income tax liability and banking covenants.

Capital

Public companies often have the ability to access larger amounts of capital, creating a lower cost of capital for a public company relative to a smaller private company, and are inclined to develop a corporate income tax strategy that does not consider tax planning on a personal level. This regularly leads to private companies being valued at a multiple lower than that of a comparable public company.

In turn, public equity market multiples may prove more appropriate when valuing a large privately held company or a public company itself.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.