Precedent Transactions Analysis
How Does Precedent Transactions Analysis Work?
Precedent Transactions Analysis is almost exactly the same as Comps Analysis. The only difference is that with this valuation methodology, you calculate multiples based on the price paid to acquire similar companies (the comparable companies) rather than what those similar companies are trading at on the market. Like with Comps Analysis, you end up with a range of multiples, but these multiples tend to be less consistent because companies are acquired for a variety of different reasons and the prices paid by acquirers can be very arbitrary. For example, a Strategic Acquirer (i.e., an acquirer that is not a Private Equity sponsor) may be willing to pay a very high price because they expect to realize significant synergies by merging with the target company. Another thing to note is that this valuation methodology tends to produce higher multiples than Comps Analysis because of something called a 'Control Premium'. In many cases, to acquire another company, the buyer must offer an amount above the company's current value, since otherwise, the target company would have no reason to sell. This 'extra' amount that buyers pay is referred to as the Control Premium. The Control Premium is the primary reason why you generally end up with higher multiples when performing Precedent Transactions Analysis.
How Do You Perform Precedent Transactions Analysis?
1. SELECT TRANSACTIONS: Just like with Comps Analysis, the first step is to screen for comparable companies (or transactions, in this case) that are similar to your target company in terms of industry, geography, size, etc. However, when screening for size, rather than comparing Revenue or EBITDA, you look at the transaction's Transaction Value, i.e., the Enterprise or Equity Value based on the company's purchase price as of the announcement date of the deal. In addition, another selection criteria to consider is time. Since the Mergers and Acquisitions (M&A) market is constantly evolving, multiples that were accurate several years ago may no longer make sense today. In most cases, you should only consider transactions that occurred within the past 2-3 years.
2. CHOOSE METRICS AND MULTIPLES: After determining your set of transactions, the next step is to select the metrics and multiples you want to use. Like with Comps Analysis, you should target to have 2-3 metrics. Revenue and EBITDA are common ones. However, unlike with Comps Analysis, you should only use trailing, or historical, metrics, such as LTM Revenue. This is because it is almost impossible to find projections for acquired companies as of the time they were acquired.
3. CALCULATE METRICS AND MULTIPLES: The third step is to calculate the various metrics and multiples for the transactions selected in step 1. With Precedent Transactions Analysis, all multiples are based on the purchase price as of the announcement date of the deal. Thus, to calculate the target company's (Transaction) Equity Value, you would multiply its total number of shares outstanding by the share price for which the buyer announced to buy the company. In other words, even if the company is trading at $50 per share, if its buyer announced that it will acquire it for $60 per share, you would use $60. To get to the company's (Transaction) Enterprise Value, you would then use its most recent Balance Sheet as of the time of the deal announcement (see Equity & Enterprise Value page to learn how to calculate Equity and Enterprise Value).
4. APPLY MULTIPLES TO TARGET COMPANY: Once you have your range of multiples, the final step is to value your target company based on that range. This step is identical to in a Comps Analysis. The only thing to note is that the output from Precedent Transactions Analysis may be less consistent and potentially higher than from Comps Analysis.
Pros & Cons of Precedent Transactions Analysis
Based on actual payments for real life transactions
Quick and easy to calculate
Reflects industry consolidation trends and potential buyers/sellers
Based on past transactions that may not be indicative of current market conditions
Difficult to find truly comparable transactions
Data is limited and may be misleading
Multiples may vary over a wide range and may be affected by unrelated factors