New on FinoLib · Volume II: Capital Markets
I have just published a new article on FinoLib, my free finance education library: Precedent Transaction Analysis and Sum-of-the-Parts Valuation. It is part of Volume II: Capital Markets. Below is a summary of the topic in plain, expert language, so you can follow the idea even before you open the full article.
1.8 Precedent Transaction Analysis
The idea in plain words
Precedent transaction analysis values a company by looking at what buyers actually paid for similar companies in completed deals. Those prices include a control premium, which is the extra a buyer pays to own and run the whole company. So the answer tells you what a buyer of the entire company might pay, not what a small shareholder’s slice is worth.
Key points
■A 10.8× deal median implies $26.40 a share for Ridgeline, 28.5% above the comps value: leverage magnifies a 22% multiple premium.
■A buyer can pay standalone value plus the present value of synergies; $20m of pre-tax savings supports at most 10.35×.
■Winning offer premiums average around 40% to 50% over the price two months before the bid in large-sample studies.
A closer look
Precedent transaction analysis is comps’ sibling, but built from actual completed M&A deals rather than day-to-day trading prices of standalone public companies. The method: find past transactions involving similar companies, calculate the multiple the acquirer actually paid (typically EV/EBITDA or EV/Revenue based on the target’s financials at the time of the deal), and apply that multiple to the company being valued today.
Decision rule
Use precedent multiples only for change-of-control questions: a sale, a takeover defense, a fairness opinion. Weight deals from the last three to five years and from a similar rate environment; if fewer than three remain, show the deals individually. Then test the implied price against the synergies a plausible buyer can capture: if the precedent median exceeds standalone value plus the present value of those synergies, assume most buyers will walk away and treat the upper end as unlikely.
The costliest mistake
Paying a control multiple for a minority stake. A minority investor cannot direct cash flows, replace management, or harvest synergies, so the control premium is not theirs to collect. Buying Ridgeline shares at the precedent-implied $26.40 when the standalone comps value is $20.55 overpays by $5.85 a share, or 28.5%, and that gap closes only if someone later bids for the whole company. Value minority positions on trading comps and the DCF; use precedents only when you are paying for, or being paid for, control.
1.9 Sum-of-the-Parts Valuation
The idea in plain words
Some companies run several different businesses under one roof. Sum-of-the-parts values each business separately, using the measure that suits its own industry, adds the results, then subtracts head-office costs and debt. If the total is above the company’s market value, the market is applying a conglomerate discount. But only the part of that gap that survives taxes and the cost of splitting the company up can really be collected.
Key points
■Corvane’s parts are worth $53.20 a share against a $44.00 price: a 17.3% discount.
■Value financial subsidiaries on equity and capitalize head-office costs.
■Tax on a sale cuts realizable value to $48.58; a qualifying §355 spin-off avoids that tax.
A closer look
Some companies operate distinct businesses under one roof — a conglomerate with a telecom arm, a retail arm, and a financial services arm, each with different growth rates, margins, and risk profiles. Valuing the whole company with a single blended multiple can badly misprice it in either direction. Sum-of-the-parts (SOTP) valuation instead values each segment separately, using the DCF or comps method most appropriate to that segment’s own industry, then adds the pieces together (minus any corporate-level costs or debt) to reach a total.
Decision rule
Build a SOTP when a company’s segments differ in growth, margin, or the multiple their industries trade on by enough to matter (as a heuristic, peer multiples more than about two turns apart). Value financial subsidiaries on equity, capitalize unallocated corporate costs, and subtract the tax and separation costs of the route that would unlock value.
The costliest mistake
Quoting the gross SOTP. Leave out Corvane’s head-office costs and the tax on a sale, and the parts add to $3,600m + $3,000m + $1,200m − $2,000m = $5,800 million, or $58.00 a share: a 24.1% “discount” against $44.00. The realizable figure is $48.58, a 9.4% discount. An investor who buys at $44.00 expecting $58.00 is counting on $9.42 a share that no transaction can deliver. Always net out corporate costs, taxes, and stranded costs before calling a discount.
What the full article covers
In the full article I take you through these sections:
■1.8 Precedent Transaction Analysis
■1.9 Sum-of-the-Parts Valuation
It includes worked examples, a look under the hood at the mechanics, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume II: Capital Markets
Read the full article on FinoLib
The complete article, Precedent Transaction Analysis and Sum-of-the-Parts Valuation, with every worked example, diagram, quiz and source, is free to read in Volume II, Capital Markets on finolib.com.
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