One of published indices of unquoted company achieved exit multiples has recently been published and shows a record level.
Argos Soditic is an independent European private equity Company supporting management buyouts of medium sized companies and has offices in Paris, Geneva, Milan and Brussels. The Argos Index measures the trends of euro zone private mid-market company valuations. Carried out by Epsilon Research for Argos Soditic and published every three months, it reflects median EV/EBITDA multiples, on a six-month rolling basis, of mid-market M&A transactions in the euro zone.
It has shown steady growth since 2013 and the latest end June results are a record 9.9x.
Before you get geared up to sell your company for this multiple you need to dig into how these indices are constructed. Bear in mind that this is a basket of different types of companies, and is categorised more by the size of deals and the availability of data (always an issue in private company valuation reporting). The index targets deals in the 15M to 500M range for EuroZone countries and only deals where a majority stake has been acquired. It also excludes some industries such as financial services, real estate and interestingly "high tech" (which it doesn't define). The latest results are based on deals with an average Equity Value of 142M Euros.
However as with all indices it's the trend that's useful - and it's certainly a reason to be cheerful.
PEM Corporate Finance's regular publication "Valuation Snapshot" tracks Argos and other indices to take the temperature of private company sales prices on an approximately quarterly basis. Here's a link to the latest one. If you have a look you'll see that what's also interesting is how the various indices diverge from time to time and why.
I always stress the need for numbers in any of our reports at PEM Corporate Finance to have some narrative, some thought, some insight to go with them. Otherwise one might conclude anything or nothing from them.
So I was interested to read a rather doom laden article in today's Insider email newsletter. "East of England Deal Market Declines - Experian". This is reporting on Experian's H1 2018 figures for deal doing activity nationally and around the country by region. For the East of England it went on to report that "the value of deals struck in the East of England in the first has 2018 suffered a steep drop, according to new data released by Experian" "Values fell significantly by 75% to £3.5Bn from the £14.1Bn announced 12 months ago."
Now on the face of it that's true, and pretty much lifted from the Experian report. What it doesn't do is ask why. This drop is compared to the same period last year. So a quick look at the Experian report for H1 2017 shows that the 2017 period included two huge deals, the sale of a stake in Arm Holdings plc to Vision Fund Japan for £6.41Bn and Tesco's acquisition of Booker Group plc for £3.7Bn. So the two largest deals in 2017 were together worth £10.11Bn. In H1 of 2018 the two largest deals were the sale of petrol station/convenience store group MRH GB for £1.2Bn and the sale of Northgate Public Services to a Japanese buyer for £0.475Bn, taken together there were worth £1.675Bn.
The trumpeted 75% decline in deal value between H1 2017 and H1 2018 came to £10.6Bn. In other words 80% of that decline was due to the two largest deals in 2017 being particularly big.
Can you conclude from this that the market is in decline? Don't think so.
However over the same period there was a 23% drop in the number of deals from 324 to 249. Given the drop by value is so skewed by those two big deals, this probably means a real slowing in volume of smaller deals. Harder to be sure why. This might be of more concern, although anecdotally we just don't see any slowing in activity with many companies seeking to transact, and sustained appetite from overseas buyers and financial players alike.
So you can put narrative on the value decline, but as regards the volume decline it's much more difficult to conclude as to why from this data.
A recent finance editorial in The Guardian on the 21st Century Fox v Comcast battle for Sky was critical of the Sky independent directors. It felt they should be embarrassed at recent events and should realise that valuation is art not science.
Too good to miss?
Paraphrasing the argument - in 2016 the independent directors felt a £10.75 per share cash offer was too good to miss. Surely offers 40% above the previous weeks share price don’t come a long too often. In fairness at that time the share price had fallen from £11 in April 2016 to 769p as the market fretted about Netflix and BT. And you can be sure that Brexit fears didn’t help either. But at the same time based on the fundamentals including the benefits to be derived from getting Sky Italia and Sky Deutschland motoring properly UBS analysts reckoned a fair price for Sky was £13.70. So they’d not have been sellers at that price.
Today in 2018, with the political and regulatory issues behind them the real bidding has begun and the action is around the £14.00 to £14.75 range - so far.
Price v Valuation
This is all about price v valuation. So what are the lessons? Well the discussions at the board are of course mostly about price. First time around in a jittery market, amidst fears about market trends (the threat from streaming), and with a one horse race the independent directors view on price wasn’t too bullish. They obviously weren’t feeling too confident. Either that the value was light, nor were they sufficiently robust to turn it down and take and flak from further share price decline afterwards. So that was all about what price to accept.
But back in 2016 UBS valuation opinion based on fundamentals was clearly suggesting something much higher – I’d be surprised if that wasn’t also the view in the Murdoch’s camp.
Now it looks so different. Better performance, better market sentiment, and true competitive bidding is driving a value c£7Bn higher than before! No wonder Sky shareholders were angry in 2016.
The above is all about how it felt for the sellers, for some insight into how it might have felt on for the purchasers have a look at this blog post on the PEM Corporate Finance website on how to pitch an acquisition offer.
The need for competition to get the best price
Taking the lesson a step further this really underscores the need to sell your business at a time of your choosing and to get a competitive process going. It also demonstrates graphically how much higher a price you might get as a result of real competitive tension between strategic buyers.
You get what you pay for, and cheap ill thought through business valuations could lead to costly strategic mistakes.
Last year a London based business I was working with shared with me a formal valuation they’d had done for them by a UK national business which specialises in company comparison and (ostensibly) valuation. It had cost them less than £500. To be precise £499 + VAT which is a not-at-all cheesy way to price it!
Of course price doesn’t necessarily give any indication of quality, or value. Usually such cheap valuations are machine driven, very mechanistic and only as good as the assumptions fed in. Garbage in garbage out etc.
But what really shocked me about this report was that the basis of calculation was just plain wrong. It looked as if it was wilfully designed to generate as high a number as possible however meaningless.
So what was wrong with it? Here’s my 3 biggest objections to it, which could also be read as a three step method to produce a meaningless and overstated valuation:
STEP 1: Take profit and add back ALL directors’ costs.
Valuations need to be based on a considered view of the businesses sustainable underlying level of profitability. It’s usual to make an adjustment to private company profit figures before using them for valuation to allow for one off costs or profits. Most commonly one needs to adjust to make sure the profit is arrived at after deducting a fair cost for the directors actual economic input to the business. Put simply you’d add back their actual emoluments and deduct the “going rate” for the actual role they were going.
The offending valuation just adds back ALL directors’ costs and makes no deduction, on the spurious logic that the new owners will do things differently. But surely the business still needs managed?
STEP 2: Apply after tax multiples to before tax profits
This is mixing apples and pears and is guaranteed to give the wrong answer. The business being valued was successful and profitable and making a good return on its assets. So taking an earnings multiple approach was fine.
The valuation firm used PE (price Earnings) multiples, and cited its use as a metric in the stock market. That’s fine but it needs to be applied to after tax, after interest profit as that’s how it’s derived and used in the quoted market. To apply it to pre-tax, pre-interest, pre-directors profit is meaningless and overstates the valuation.
The valuer also stated that “most valuations are done this way” – actually no. Most unquoted businesses are valued on an Enterprise Value to EBITDA basis. And a compelling reason for that is that otherwise you need to make complicated adjustments to reflect the funding structure and taxation regime differences between benchmark companies and those being valued.
STEP 3: Add total assets to your valuation
It’s correct to add surplus assets to an Enterprise Value but not any other assets. The logic is that the assets are involved in generating the profit stream that you’ve valued so to add them to the valuation would be to double count. If it’s a poorly performing business you might just use the true value of the net assets as a measure of valuation but that’s a different story.
To compound it all this valuation then took the result of step 2 above and added total net assets – which in this instance added a totally spurious 50% uplift to the valuation.
At the end of the day the business owners who purchased this valuation report hadn’t wasted much money on it – but the true cost of it could easily have been poor or downright wrong decision making based on its conclusions. After all it probably overstated valuation by nearly 60% taking all three mistakes together! As it happens we had a discussion with them about a realistic valuation range which they used as input to their strategic discussions on exit and succession planning.
The latest Argos Mid-Market Index which shows movements in private company prices has just been published. It shows data up to Q3 2017 and indicates a record high of 9.5x. As you can see from the graph it has been steadily climbing since 2009. So if you're a business owner it's a good time to think about exit. Or at any rate to make sure you have a credible exit or succession plan in place. Many owners of private companies have much of their wealth locked up in their shareholding and so even an equity release transaction - perhaps by selling shares to a third party like a private equity house can help balance their personal portfolio.
The other factor I now start to hear in conversation with business owners is concern about the tax regime that a new government might bring. The capital taxes regime re the sale of company shares is particularly benign with Entrepreneurs' Relief effectively reducing the rate to 10% on the first £10M of lifetime gains. Whilst Entrepreneurs' Relief was brought in by a Labour government there is an up swell of concern that a Corbyn led government might change things.
None of this may happen of course but it does underscore the need for every business owner to have a plan for exit and succession - even if it is explicitly not intended to happen for some time.
We're running our Business Exit Strategies Seminar in Stevenage on 23 November the day after the Chancellor Philip Hammond's budget speech. So we should have clarity at least on his short term tax plans.
Our event, which is free, gives useful insights into a range of topics:-
The current M&A market
How to build value in your business
How to achieve succession through a management buyout
Tax - how to mitigate and also how to use your tax affairs to build value in your company
Company sales - how to sell your business, pitfalls, why some companies don't sell
We're once again running our Business Exit Strategies seminar this time in Stevenage, Hertfordshire on 23 November 2017.
This is aimed at business owners who are beginning a planning cycle towards exit or succession or indeed those who plan an exit or sucession event in the short term. It's an interactive and engaging morning that will send attendees back to base with useful insights.
We've all been to seminars that are just overt sales pitches, or frankly boring. So we set out to make sure our events are neither. Our primary objective is to inform, and leave our guests feeling it's been a morning well spent. Just ask any previous attendees.
We cover a range of topics including
Developing a workable ownership strategy
Succession buyouts and MBOs
Valuing a business for sale
Tax efficient exit planning
How to sell your business
Negotiating the deal
And the key benefits of coming along are
A practical overview of how to plan and implement your strategy for exit or succession
A clear understanding of the selling process
Understand how succession buyouts are an alternative to selling
Like Hercule Poirot you should be on the lookout for ulterior motivation. Was the forecast prepared with one eye to selling the business (usually inflated) or getting a valuation for a matrimonial dispute (this often produces a low valuation if the business owner is the defendant). Or perhaps it was prepared for bank funding – in which case be sure the bank will scrutinise and sensitise the forecast.
Poor track record of forecasting
If the business has historically been poor at predicting its results which should it be different now?
The pattern of growth or margins look odd
It’s always possible to benchmark the figures against public companies or other data. If the business producing the forecasts has wildly different growth rates, or margins one needs a good explanation as to why that should be.
Forecasts prepared in isolation by the finance director
The CFO or FD in the business needs to canvas inputs from the key mangers in the business before he or she can produce anything meaningful.
The forecast is based on a huge assumption
If there’s one or two huge assumptions that drive the forecast, such as being able to raise millions of pounds of equity finance, or winning a significant new contract then you should consider what happens if those assumptions don’t prove realistic.
Forecasts conjured out of thin air
Of course if there are no, or few, supporting assumptions to check out then the forecast will lack credibility. I recently valued an early stage technology company where it quickly became clear that the forecasts beyond the first twelve months were just round figure guesses – so I had to discount them altogether in my appraisal.
No balance sheet
I do sometimes see forecasts based on a profit and loss account and some cash flow assumptions. Without a balance sheet a vital logic check is missing.
I was interested to read an article on East Anglian business website bizeast with the headline "Firms at risk from 'locking up too much cash' ". What is too much cash?
The article was based on a Lloyds Bank report - Lloyds are pushing a working capital management product. However if you read the Lloyds page it's clear that its not about having too much cash, but about having too much cash locked up in working capital. As firms grow, unless you manage things tightly or have a very positive working capital cycle there's usually a suck in of cash as the debtor book and stockholding grow unless fully covered by creditor growth. So a very misleading headline in bizeast.
So let's assume you manage your working capital tightly - can you still have too much cash? Well yes sometimes. Businesses often don't distribute all of their profits, and we see many firms with large cash balances. This is partly for the "sleep at night" reason of having a cash buffer, and also often because of the high tax rates on dividends.
When you come to sell the company - typically subject to an arguement with the buyer about how much of the cash is surplus (this is where your M&A adviser can really earn their fee) you should expect to be paid £ for £ above the Enterprise Value of the company for any surplus cash. That's all good. The only circumstance where surplus cash can be too much cash, is in some circumstances where it's a disproportionaly large component of the price or the balance sheet you might run into trouble claiming Entrepreneurs' Releif. So yes, in a few circumstances you can have too much cash - and this is where your tax adviser needs to help.
So just to string together a few cliches to finish - cash IS king, the cheapest way to fund your business is good housekeeping (ie working capital maangement) and don't beleive everything you read in the newspapers or on the internet!
Two experts can arrive at valuations of a business. Experts aren’t in the business of advocacy, and shouldn’t two trained and experienced professionals come up with the same answer? Here’s some good reasons they might differ.
REASONS FOR DIFFERENCES IN EXPERT OPINIONS
Experts can be reacting to different legal guidance.
Differences in availability of information
Access to data may be unequal. Valuers can only conclude based on the available evidence.
Access to Management
Sometimes the valuer for one “side” in the case is denied the level of access to management granted to the other expert.
Using different valuation methods
Valuers make judgements as to which of the three main valuation methods to use. The asset approach focuses on assets values, the income approach deals with income capitalisation or discounted cash flow and the market approach uses comparisons with public companies and with analogue transactions. Valuers need to be aware of their merits and disadvantages.
The asset approach is usually of limited use for profitable operating companies.
The market approach is powerful but comparable companies and transaction need to be selected carefully, and for some businesses it can be difficult to find suitably close comparators.
In the income approach there is much subjectivity around future cash flows (especially the terminal value) and appropriate levels of discount.
Judgements around these choices hugely influence the valuation opinion.
Different judgements, different assumptions
Experts providing business valuations must make assumptions and judgements on a wide range of issues:-
Asset methods – what basis to value the assets
Earnings methods – how to adjust and analyse the cash flows. Some element of judging the future from the past is required. Adjustments need to be made to normalise profits and to reflect working capital changes.
Forecast assumptions for DCF – each difference of judgement shifts result. The terminal value in a DCF calculation can account for more than 50% of the value – so is it reasonably arrived at, what multiple is used? What sensitivity analysis has been applied?
Public company comparables – is this method appropriate? Are the selected companies sufficiently comparable to reach a meaningful conclusion? Have differing growth rates and risk between the comparable companies and the company being valued been accounted for?
Analogue transactions –are the selected comparable transactions actually comparable to the subject company.
Premia and discounts – for example for control - or minority holdings - are they defensible?
Weightings assigned to the different methods – are they reasonable?
One would hope they’ll be discovered and corrected before anyone ends up before a Judge.
WHAT ELSE MIGHT INFLUENCE THE COURT
The court may also be swayed by the relative credibility of the reports and the testimonies of the experts. Also, how compelling the conclusion is in comparison with other evidence? Does it make sense?
PEM Valuations also providing M&A advice to business owners, so we have the advantage of being able to apply the “gut test” to any valuation opinion. In short do we believe that someone would pay that amount for the business being valued?
This 2012 High Court case is interesting for the comments made by Justice Eder about Expert valuations.
Stabilus was a leading German manufacturer of gas springs and hydraulic vibration dampers used in the automotive industry which was the subject of a number of transactions. In 2008 it was bought by Paine & Partners LLC for €519M. Shortly afterwards got into financial difficulty and underwent a major restructuring in 2009 which carved up all the value to the Senior Lenders leaving nothing for the Mezzanine lenders.
Unsurprisingly – with €83M at stake in the Mezz layer – the Mezzanine lenders challenged the validity of the restructuring. Three different valuation firms gave opinions and three of the “big four” accounting firms were involved one way or another.
The judgement 100 pages long judgement had some key lessons for business valuation.
Use of previous valuations
If they’ve been prepared for internal reporting purposes rather than “fair market value” then they’re not suitable support
Adjusting forecasts without considering the reasons for variations is not acceptable, and past variations from plan are not an automatic indication that there will be future variations.
Other Experts Reports
The Expert must request to see other Witness reports to check assumptions and any deviations from their viewpoint. Any deviations must be fully supported.
Discount to EBITDA multiples relative to guideline companies
The judge was happy that EBITDA multiples should be discounted. He commented that applying a discount is qualitative rather than quantitative.
The Expert needs to compare the risk, size, growth pattern of the business being valued to the guideline company when estimating a suitable discount. Stabilius had a lower growth rate than the rest of the industry which justified a lower multiple.
The valuer must focus on the facts and business outlook as at the valuation date. Hindsight is not a sense check for assumptions at the valuation date.
Ultimately the Judge agreed for the most part with the American Appraisal valuation – that the mezzanine debt had no economic value at the date of valuation.