What is Transaction Multiples (M&A)?

Transaction multiples or Acquisition Multiple is a method to look at the past Merger & Acquisition (M & M & M & M&A) transactions and value a comparable company using precedents.

It is based on the premise that the value of the company can be estimated by It is based on the premise that the company’s value can be estimated by analyzing the price paid by the acquirer company’s incomparable acquisitions. This valuation method is usually used by financial analysts in corporate development private equity firmsPrivate Equity FirmsPrivate equity firms are investment managers who invest in many corporations’ private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP.read more, and investment banking segments.

Also, have a look at Comparable Company AnalysisComparable Company AnalysisComparable comps are nothing but identifying relative valuations like an expert to find the firm’s fair value. The comparable comp process starts with identifying the comparable companies, then selecting the right valuation tools, and finally preparing a table that can provide easy inferences about the fair valuation of the industry and the company.read more.

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Transaction Multiple Calculation

The obvious question is how financial analysts calculate this multiple. It has two answers. One is short, and another is long.

In short, it’s all dependent on how they identify similar businesses and look at their recent M&A deals. And depending on that, they value the target company.

The long answer is a little more detailed. Let’s elaborate step by step.

Step 1 – Identify the Transaction

We can identify the transaction using the following sources –

  • Company Websites – Go through the comparable company’s press releases and recent activities section. Go through the other general strategy sections to see the transactions which the company discusses most.Industry Websites – You can also refer to industry websites like thedeal.com, which contains almost all the deals from various sectors.Bloomberg CACS – If you have access to the Bloomberg terminal, you can also check out the CACS section of the comparable companies.

 Step 2 – Identify the right multiples.

For having more clarity on the same, look at the following factors –

  • Time of the transaction: The most important filter you should use while looking at M&A transactions is the timing of each transaction. The transactions should be very recent.The companies revenue involved in the transactions: You need to go through the annual reportThe Annual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more to find out the latest revenues. The idea is to choose companies that are similar in revenues/earnings.Type of business: This is one of the key factors. It means you should look at the products, and services, target customers of the businesses and select those businesses as comparables. It would be best if you looked at businesses of similar types.Finally, the location: The last factor you should look at is the location of the comparable businesses. A similar location would justify because then you would be able to look at regional factors, plus you can see what challenges those businesses in the same location faced.

Step 3 – Calculate the Transaction Multiple Valuation

You need to consider three multiples while looking for similarities in previous transactions. These multiples may not give a very accurate picture of the business, but these multiples will be conclusive enough to make a decision.

  • EV/EBITDA: This is one of the most common acquisition multiples financial analysts use. The reason investors/finance professionals use this multiple is that EV (Enterprise ValueEnterprise ValueEnterprise value (EV) is the corporate valuation of a company, determined by using market capitalization and total debt.read more) and EBITDA (Earnings before interest, taxes, depreciation, and amortization) both take debt into account. The good range of EV/EBITDAEV/EBITDAEV to EBITDA is the ratio between enterprise value and earnings before interest, taxes, depreciation, and amortization that helps the investor in the valuation of the company at a very subtle level by allowing the investor to compare a specific company to the peer company in the industry as a whole, or other comparative industries.read more is 6X to 15X.EV/Sales: This is also another common multiple used by financial analysts/investors. This multiple is significant for certain cases where EV/EBITDA doesn’t work. A start-up has a negative EV/EBITDA. And that’s why for small businesses that just got started, analysts use EV/Sales multiple. The usual range of EV to Sales Ratio is the valuation metric which is used to understand company’s total valuation compared to its sales. It is calculated by dividing enterprise value by annual sales of the company i.e. (Current Market Cap + Debt + Minority Interest + preferred shares – cash)/Revenueread moreEV/SalesEV/SalesEV to Sales Ratio is the valuation metric which is used to understand company’s total valuation compared to its sales. It is calculated by dividing enterprise value by annual sales of the company i.e. (Current Market Cap + Debt + Minority Interest + preferred shares – cash)/Revenueread more is 1X to 3X.EV/EBIT: This is another acquisition multiple that investors and financial analysts use. It is essential because it takes the wear and tear of the company into account. For technology and consulting companies (the companies that are not so capital intensive), EBIT and EBITDA don’t make much difference. EBIT is lesser than EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business’s performance with that of its competitors.read more because depreciation and amortization are adjusted in EBIT. As a result, EV/EBIT is usually higher than EV/EBITDA. The usual range of EV/EBITEV/EBITThe EV to EBIT ratio is an important valuation metric that determines whether a company’s stock is expensive or cheap in comparison to the broader market or a competitor.read more is 10X to 20X.

Example

Below are the acquisition details of the comparable acquisitions.

You need to screen the right transactions and filter out the rest. How would you do that? You would look at the company profiles and understand the transactions closely, and they will only choose the ones that fit the bill.

Then, you would use the right multiples (in this case, we used three) and apply the acquisition multiples to the target company you’re trying to value.

Next, you would value the company by using the right acquisition multiples.

  • First, you would look at the range of the acquisition multiples – are they high or low.And depending on that, the valuation would be done. And we would have a low range and a high range valuation.It would be best if you did this for all comparable transactions. And then finally, we will create a chart to find out the common thread.If the right acquisition multiple for your company is EV/EBITDA, the average of 10.25x will apply to the target company.

Advantages

  • Anybody can access the information available; because it’s public.Since the valuation is based on range, it is much more realistic.Since you’re looking at different players, you can understand their strategies.It also helps you understand the market better.

Disadvantages

  • While valuing the target company, individual biases would come into place; no one can avoid them.Even if various factors are considered, there are still many more factors that are not considered.Even if the deals are compared, no deal can be the same. There would be one or more factors that would be different.

Transaction Multiples Valuation Video

This has been a guide to what is transaction multiple. Here we learn to shortlist the transaction, identify the correct acquisition multiple, and finally calculate the value of the target company using the right valuation multiple. You may also learn more about valuation from the following articles –

  • Formula for Equity MultipleTransaction RiskWhat is Capital Intensive?Types of Financial Models