a deeper look into market approach tran sactions

BUSINESS VALUATION 4 VALUATION STRATEGIES

A Deeper Look Into Market Approach Transactions

When using the marketapproach, analysts must fullyunderstand what observable datais relevant to the subject company,and consider whether to includesynergistic transactions in their analysis.

R U S S E L L T. G L A Z E R

a particular individual, owner, orinvestor. Unlike the hypotheticalbuyer and seller, we take into con-sideration a multitude of individ-ualized factors when consideringinvestment value, including…:

[1.] Risk aversion or tolerance

[2.] Motivation of the parties

[3.] Synergies and relationships8

In certain circumstances, investmentvalue can approximate fair market val-

ue. “Whether or not [investment value]also represents fair market valuedepends on whether the assumptionsused would be accepted by a consensusof market participants.”9 However, forpurposes of this discussion, it is assumedthat investment value does not approx-imate fair market value.

Synergistic Value. Sometimes the stan-dard of value is synergistic value, whichis essentially the same as investment val-ue, where one or more synergistic advan-tages (cost savings, cross-sellingopportunities, greater growth potential,stronger buying power, etc.) are expect-ed to accrue to the acquirer.

The actual price paid for acquiredcompanies may thus be based onfactors and synergies that onlythose specific purchasers were ableto identify and/or assimilate….The value of the subject interest asderived from a transaction-relatedmultiple may thus run the risk ofreflecting the value of (i.e. the pre-vailing conditions for) that partic-ular peer during that particulartransaction rather than the more‘neutral’ market value set by a well-informed financial investor….10

For purposes of this article, it isassumed that synergistic value does notapproximate fair market value.

Fair Value. Alternatively, a valuationengagement may seek to determine thefair value of the subject interest, whichis defined either by statute (e.g., mari-tal dissolution or oppressed sharehold-er cases) or the accounting literature(purchase price allocation, goodwillimpairment, and stock options for finan-cial reporting). However, while the fairvalue standard is generally used in liti-gation or for financial reporting pur-poses, it is not typically used in anactual, marketplace transaction, and sois unlikely to find its way into the mar-ket transaction databases.

So, when selecting transactions foruse in the market approach, it is impor-tant to filter out not just those compa-nies that are insufficiently similar to thesubject operationally, but also thosetransactions that do not reflect the moti-vations of the buyer inherent in the stan-dard of value being sought. Thus, if thevaluation engagement is of the fair mar-ket value of the subject, then the analystshould take steps to exclude investmentvalue or synergistic value transactionsfrom the analysis.

In the same manner, sales of dis-tressed companies should be excludedwhen valuing a healthy, profitable com-pany. Distressed companies can usual-ly be identified and screened out by anexamination of their financial statementsfor operating losses, negative equity,inadequate working capital, high levelsof debt, etc.

However, it can be more problemat-ic to identify and screen out investmentvalue or synergistic value transactions.The motivations of the buyer cannot beknown with certainty, and any hopedfor synergies or other advantages andtheir effect on the transaction price can-not be identified and separately ana-lyzed, so that the resulting pricingmultiple can be adjusted accordingly.

For purposes of this article, it isassumed that fair value does not approx-imate fair market value.

Motivation of Public BuyersAlthough special motivations of the buy-ers cannot always be known, perhapsthey can be surmised or inferred by the

VALUATION STRATEGIES 7BUSINESS VALUATION May/June 2015

Every method that can be reliablyapplied should be considered in eachcase. Which approaches are actually useddepends on a variety of factors, not leastof which is the quantity and quality ofthe available empirical data and itsapplicability to the subject interest. Thisarticle examines the responsibility ofanalysts to fully understand the availabledata when apply ing the marketapproach, and determine whether syn-ergistic transactions and values shouldbe considered.

Data RelianceIn the market approach, the empiricaldata relied on should be derived from amarketplace where business interestssimilar to the subject trade in arm’s-length transactions among willing buy-ers and sellers, and sufficiently analogousand relevant pricing multiples can bedeveloped.

“Similar” refers to the nature of thebusiness being appraised. It encompassessuch business attributes as: • Business size. • Markets served. • Depth of management. • Information processing systems. • Level of technology utilization. • Probable future earnings growth.

“Relevant” refers to the desires andexpectations of the probable willing buy-er or investor. As noted by the late RayMiles, founder of the Institute of Busi-ness Appraisers, this includes: • Risk tolerance (degree of r isk

assumed). • Liquidity of investment. • Degree of management involvement. • Probable holding period, etc.1

Rev. Rul. 59-602 states that:

[In] selecting corporations forcomparative purposes, care shouldbe taken to use only comparable

companies. Although the onlyrestrictive requirement as to com-parable corporations specified inthe statute is that their lines ofbusiness be the same or similar,yet it is obvious that considerationmust be given to other relevant fac-tors in order that the most validcompar ison possible w i l l beobtained.

Standard of ValueThe standard of value of the particularengagement influences the transaction-al motivations of both the buyer andseller (either hypothetical or actual),and must be considered in the valua-tion. Ray Miles addressed this implicit-ly by reference to “the desires andexpectations of the probable ‘willingbuyer’ or investor.”3 Similarly, Rev. Rul.59-60 states that “consideration must begiven to other relevant factors,” whichwould include the motivations of theparties, since differing objectives wouldlikely lead to different values for thesame subject company. “Specific func-tions of a valuation require the use ofspecific methods or processes, each ofwhich can derive dramatically differentvalue conclusions…Every private com-pany, therefore, has a number of differ-ent values at the same time, dependingon the purpose and the function of thevaluation.”4

Hence in the market approach it isimportant to match the transactionsdeemed to be comparable to the subject,with the proper standard of value beingapplied to the engagement.

Fair Market Value. Under the fair mar-ket value standard “the willing buyerand willing seller are hypothetical per-sons dealing at arm’s length, rather thana particular buyer or seller. In otherwords, a price would not be consideredrepresentative of fair market value ifinfluenced by special motivations notcharacteristic of a typical buyer or sell-er” (emphasis added).5 Fair market val-ue is the typical standard of value for taxpurposes (charitable donations, gift,estate, stock options income) and is

understood to assume a financial buy-er; so that fair market value “remainsfree from any type of extra or additionalsynergistic values or premiums (strate-gy, economies of scale, acquisition ofmarket shares, etc.) which are likely tobenefit only one, or a certain group of,specific investor(s).”6

Investment Value. For the investmentvalue standard, the valuation exercise isconducted with a particular buyer inmind; that is, “the value to a particularinvestor based on individual investmentrequirements and expectations.”7 Sucha valuation exercise will likely includedifferent estimates of earning power,perception of risk, financing costs, andconsideration of synergies than it wouldfor fair market value.

We have observed that fair marketvalue necessarily involves hypo-thetical buyers, hypothetical sellers,and a hypothetical marketplace.The term investment value differssignificantly from fair market val-ue in that investment value denotesvalue to a particular buyer, seller,owner or investor. Investment val-ue therefore considers and exam-ines value from the perspective of

6 VALUATION STRATEGIES May/June 2015 BUSINESS VALUATION

1 Miles, “The Direct Market Data Method:Theoretical Underpinnings,” (Institute of BusinessAppraisers), www.go-iba.org.

2 1959-1 CB 237. 3 Note 1, supra. 4 Slee, Private Capital Markets, 2nd Ed., (John

Wiley & Sons, 2011), page 20, emphasis in theoriginal.

5 Pratt, Valuing A Business, 5th Ed., (McGraw-Hill,2008), page 42.

6 Bernstrom, Valuation—The Market Approach,(John Wiley & Sons, 2014), page 9.

7 International Glossary of Business ValuationTerms.

8 Laro and Pratt, Business Valuation and Taxes,(John Wiley & Sons, 2005), page 15, emphasis inthe original. Note that not all the factors are listedhere.

9 Pratt, Valuing A Business, note 5, supra, page 43. 10 Bernstrom, note 6, supra, page 10.

RUSSELL T. GLAZER, CPA/ABV, MCBA, ASA, ABAR,CVA, MBA, is a partner and member of the Business Val-uation & Litigation Services Group at Gettry Marcus CPA,P.C., an accounting, tax, and consulting firm in New York.He may be contacted at [email protected]. Spe-cial gratitude to Jarred R. Berman, CVA, CFE, CFIP, forhis invaluable assistance in the financial analysis.

Business appraisers have three approaches tochoose among when valuing a business interest—the income, market, and asset approaches.

hubris, the more the transaction priceleans toward investment value versusfair market value.”19

Thus, not only would a public buyerbe willing and eager to outbid a small-er private buyer to acquire the same ben-efit stream, a public buyer often overpaysfor the benefit stream. Therefore, it isimportant to ascertain that the transac-tions relied on in the market approachreflect the same standard of value, andthe same participant motivations, as thesubject company in a valuation engage-ment. The discussion thus far hasfocused on the buyer’s motivations, buttransactions including unusual sellermotivations should be excluded, as well.Hence, if a transaction is the result of aforced sale, or some unusual compul-sion on the part of the seller, it, too,should be excluded from a valuation thatpurports to reflect fair market value.

Fundamental AdjustmentsFrequently, when using public companiesto value a smaller, privately held subjectcompany, a “fundamental adjustment”is applied to acknowledge the differences

between the acquired company and thesubject company. In this manner thepricing multiple is adjusted for the “rel-ative differences in risk and expectedgrowth between a subject company anda selected group of public guideline com-panies.”20 Size is also often a considera-tion in the fundamental adjustment, aspart of the difference in risk.

However, without knowing a greatdeal more information, the fundamen-tal adjustment cannot adequatelyaccount for the value of any synergies forwhich the public acquirer paid, let alonethe value of synergies for which the pub-lic acquirer overpaid.

For the analyst, the underlying rea-sons for paying synergistic premiumsare not relevant. The overarching pointis that public companies pay for syner-gies, and often overpay, making thesetransactions ill-suited for an analystseeking the fair market value of the sub-ject company.

To be sure, there are instances whererelying on transactions with public com-pany buyers are appropriate. A funda-mental tenet of the market approach isto match the comparable transactions

as closely as possible to the subject com-pany. Hence, if the purpose of the val-uation is to determine the synergisticvalue of the subject company, then useof synergistic comparables is entirelyappropriate. Such could be the case, evenwhere fair market value is the standardof value being sought.

Pool of Potential Buyers. Typically,the fair market value standard excludesspecial motivations, such as synergies.However, if the pool of potential buyersconsists of likely synergistic buyers, thenthe influence of these buyers on the fairmarket value should be considered.“[T]he willing seller would investigatethe marketplace for the stock of the sub-ject business and may conclude that themarket consists of a number of poten-tial synergistic buyers.”21

Thus, if there are synergistic trans-actions in the marketplace occurring onor soon before the valuation date, theanalyst may consider the increase in val-ue of the subject due to the synergiesavailable, since that represents the mar-ketplace prevailing at the time of thevaluation.

However, other considerations mustbe made, as well. Even if synergistictransactions occurred in the time lead-ing up to the valuation date, it may bethat the subject company is not a can-didate to be acquired in such a transac-tion. “If acquisitions are typically only ofcompanies significantly larger than thesubject business, then the pool of like-ly buyers for the subject business maynot include synergistic buyers at all”(emphasis added).22

Moreover, a buyer would be unwill-ing to pay for synergies which the sell-er cannot reap on its own, and that canbe attained only by the combined enti-ty. In such a case, although the buyermay be expecting significant synergies,it may not be reflected in the price paidand should not be incorporated in theanalysis of the fair market value of thesubject. Only in a robust, competitivemarket for the company would the sell-er be expecting to share significantly inthe synergies to be enjoyed by the buy-er. “Theoreticians espouse that the syn-ergistic buyer should not give the sellerany of the benefits that the [buyer]23

expects to realize from the proposedtransaction. But the reality is that syn-ergistic buyers often give up some (and


industry in which the buyer operates.It seems likely that when a publicly heldcompany makes an acquisition, thetransaction is motivated by the expec-tation of synergies. “[S]ynergies are fun-damentally the only tangible justificationfor making an acquisition.”11 In the pre-sent author’s own, anecdotal, and unsci-entific experience, it has been observedthat when a public company is thereported acquirer in a transaction in thePratt’s Stats database, the target is invari-ably in the same or similar industry asthe acquirer. When this is the case, it islikely that the buyer was motivated by acertain degree of expectations for syn-ergies or other advantages.

Therefore, when a public companymakes an acquisition, the transaction isalmost surely motivated by synergisticopportunities that make such a trans-action fundamentally different thanwhen a private company or an individ-ual makes an acquisition. If so, then amarked differential in pricing multiplesshould be observed. It is recognized thatacquisitions by private companies maybe synergistic in nature, as well. How-ever, because of their typically largersize and broader reach, public compa-nies are likely to anticipate greater syn-ergies than their privately heldcounterparts, and probably have agreater ability to pay for them. Thereforethe public company is able to outbid asmaller, privately held company for theacquisition target.

Rate of Return. Moreover, perhaps apublicly held company, by virtue of itsgenerally greater size, geographic diver-sification, access to capital markets, high-er anticipated growth rates, and otherfactors has a lower required rate of return.This represents a form of arbitrage; every-thing else equal, when a public compa-ny acquires a smaller privately heldcompany, the value of the benefit streamacquired is immediately magnified.

Numerous studies have indicatedthat, on average, smaller compa-nies have lower pricing multiplesthan larger companies. The mainreason for this is that smaller com-panies typically have more busi-ness and financial risk than largercompanies (footnote omitted).12

This conclusion, reached fromanalysis of market data, is consistentwith income approach (cost of cap-

ital) research, which shows thatsmaller companies have higher costsof capital (higher discount rates)than larger companies. Higher dis-count rates in the income approachshould mean lower multiples in themarket approach, and this rela-tionship does, indeed, hold true.13

This would make a target company’sbenefit stream more valuable to such abuyer than the same benefit streamwould be to a competing bidder with ahigher required rate of return. The buy-er with a lower required rate of return(lower perception of risk) would be will-ing to pay more for the same level ofcash flow than a buyer with a higherrequired rate of return. Therefore, evenfor the same level of perceived synergies,public companies are likely to pay morethan private companies.

Moreover, there is a great deal of evi-dence that acquisitions by public com-panies have a high failure rate.14 Possibleexplanations for this phenomenoninclude the acquiring company’s over-estimation of its ability to improve onthe perceived inefficiency of existingmanagement, inability to realize the syn-ergies anticipated, and CEO hubris.15

“It has been estimated that upward of80% of public company acquisitions inthe 1990s were synergistic acquisitions(far higher than is the case for purchasesof small businesses).”16 There are severalpossible reasons for this. The publiccompany may be seeking synergies byacquiring a company in the same indus-try in order to either eliminate a com-petitor, make better use of the target’scustomer base or intellectual property,

or seek other potential benefits that theacquirer perceives or anticipates.

Overpayment. The tendency for pub-lic companies to overpay for synergiesis supported by empirical evidence.

“It has been well documented overthe last two decades that buyers ofbusinesses, on average, pay toomuch. Studies conducted on thepublic markets show that acquisi-tions do increase total sharehold-er value, on average. That is, theaverage postacquisition value ofthe combined acquirer andacquiree companies is greater thanthe sum of their separate preac-quisition market values. However,more than 100% of the total marketvalue increases tend to go to the share-holders of the acquiree companies withthe acquirer companies’ shareholderslosing market value.”17

“Indeed, companies spend more than$2 trillion on acquisitions every year.Yet study after study puts the failure rateof mergers and acquisitions somewherebetween 70% and 90%.”18 However,although the anticipated synergies fail tofully materialize in most cases, they arestill paid for by the acquirer.

Possible reasons for this tendency forpublic companies to overpay for theiracquisitions include the “hubris effect,”whereby “high chief executive officer(CEO) hubris leads to payment of highacquisition premiums…. The primarydifference between fair market value andinvestment value is that fair market valueis the value to a typical or hypotheticalbuyer or seller, while investment value isthe value to a particular buyer or seller.It would seem that the greater the CEO


11 “How synergies drive successful acquisitions,” asurvey of participants in Pricewaterhouse-Coopers[esq] Transaction Services Roundtable(PricewaterhouseCoopers, LLP, 2010).

12 Hitchner, Financial Valuation, 3rd Ed., (John Wiley& Sons, 2011), page 277, footnote omitted.

13 Pratt, The Market Approach to Valuing Businesses,2nd Ed. (John Wiley & Sons, 2005), page 252.

14 See, e.g., Antoniou et al, “How Much is TooMuch: Are Merger Premiums Too High?,” 14European Financial Management 268 (2008);Roll, “The Hubris Hypothesis of CorporateTakeovers,”59 J. Business 212 (1986);Damodaran, “The Value of Synergy,” (2005), avail-able at http://ssrn.com/abstract=841486 orhttp://dx.doi.org/10.2139/ssrn.841486; Chatterjeeand Hambrick, “It’s All About Me; NarcissisticChief Executive Officers and Their Effects onCompany Strategy and Performance,” 52Administrative Science Quarterly 351 (March, 1997).

15 Hayward and Hambrick, “Explaining the premiumpaid for large acquisitions: Evidence of CEOhubris,” 42 Admin. Sci. Q. 103 (1997).

16 Pratt , The Market Approach to Va lu ingBusinesses, note 13, supra, page 146. This state-ment relates to acquisitions taking place in the1990s; however, the applicability of this senti-ment to today’s marketplace was confirmed byprivate correspondence with Dr. AswathDamodaran, Stern School of Business, New YorkUniversity.

17 Pratt, note 13, supra, page 274, emphasis in theoriginal.

18 Christensen, Alton, Rising, and Waldeck, “The BigIdea: The New M&A Playbook,” 89 HarvardBusiness Review 3 (March 2011).

19 Pratt, note 13, supra, page 276, emphasis in theoriginal.

20 Mercer and Harms, Business Valuation: AnIntegrated Theory, 2nd Ed., (John Wiley & Sons,2008), page 140.

21 Grabowski, “Identifying Pool of Willing BuyersMay Introduce Synergy to Fair Market Value,” 7Business Valuation Update 1 (April 2001).

22 Id., emphasis in the original.

acquired by public companies are larg-er than those acquired by private com-panies. That is, the ranges of eachquartile, as well as the medians, are farhigher for public buyers than for pri-vate buyers. Moreover, public buyersmade stock purchases (4,489) more thantwice as often as asset purchases (2,111).Conversely, private buyers made asset

purchases more than 16 times as often(13,734 asset purchase transactions ver-sus 826 stock purchases).

Subject Company Equity. Typically, theanalyst is asked to value the equity ofthe company, not just certain assets orliabilities. Thus, the analyst must makecertain adjustments when using assetpurchase multiples to value a subjectcompany’s equity. Use of an asset pur-chase multiple will result in an indicationof value for the same assets and liabili-ties of the subject company as changedhands in the comparable market trans-action. If the subject company has assetsor liabilities that are not among thoseassumed to be incorporated in the pric-ing multiple, they must be added or sub-tracted in order to convert an indicationof value derived from an asset pricingmultiple to an indication of value of thesubject company’s equity.

For example, assume that the medi-an asset pricing multiples for the select-ed comparable transactions includefixed assets, intangible assets, and long-term debt, and exclude all other assetsand liabilities. Applying this pricingmultiple to the subject company pro-duces an indication of value only forthe same group of assets and liabilitiesof the subject company (i.e., only itsfixed assets, intangible assets, and long-term debt). This indication of value willtherefore exclude any other assets orliabilities of the subject company. Toadjust for this mismatching, the indi-cation of value must be increased for theassets and decreased for the liabilitiesheld by the subject company but notassumed to be included in the pricingmultiple. This key step is required inorder to convert an asset purchase indi-cation of value to an equity purchaseindication of value.

A problem posed by reliance on assettransactions is that the compilers of thedatabases used by appraisers can oftenmake only generalizations of what spe-cific assets are included in the purchaseprice. The Pratt’s Stats database providesthis guidance:

Based on our experience with see-ing what transfers in asset sales, wemake the following assumptions:

Commonly transferred• Inventory (if applicable to indus-

try, e.g. a CPA firm may not pos-sess any inventor y whi le aconvenience store may)

• Fixed assets • Leasehold improvements (if any) • Intangibles (such as trade name,

customer lists, etc.) • Goodwill

Rarely transferred• Cash and equivalents • Trade receivables • Real estate (this value will not be

included in the Pratt’s StatsMVIC price if transferred, butwill be noted in the “AdditionalNotes” field) 27

Liabilities. Regarding liabilities, thePratt’s Stats website does not directlyaddress the inclusion of liabilities in thepricing multiples, but cites other sources:“An asset sale is a transaction whereonly certain assets (and maybe liabili-ties) are transferred to a new owner,”28

and “Seller keeps cash and receivablesbut delivers company free of any debt.”29

However, Pratt’s Stats notes that thereare cases where the specific assets andliabilities that changed hands, and theiragreed upon values, are known:

It is important to look at the “AssetData” and “Additional Notes” sec-tions of the Pratt’s Stats transactionreport to see if a purchase priceallocation is given for the sale. Thisallocation will show you definitivelywhat assets transacted and theiragreed upon values by the buyerand the seller. A user can also lookat a group of transactions in thedatabase by industry or SIC code tosee what typically transfers.

Of the 15,845 asset purchase trans-actions reported in the Pratt’s Stats data-base, 7,064, or 44.6%, publish the valuesof the assets agreed to by the parties.In the cases where this data is not avail-able the analyst must rely on the


sometimes a great deal) of the syner-gistic value to the sellers in order to out-bid other buyers…[Therefore] thevaluation consultant must study andunderstand the market of potential buy-ers. Is the market of likely willing buy-ers entrepreneurs or financial buyerswho will value the subject business onlyas a stand-alone? Or is the market oflikely buyers made up of potentially syn-ergistic buyers?”24

Study of Pricing MultiplesGiven these important considerations,the analyst attempts to determine if pub-lic company acquisitions are priced athigher multiples than private companyacquisitions, and should therefore beviewed as two distinct, separate popu-lations of data.

Several databases are available thatpublish the purchase prices paid for theacquisition of private companies, includ-ing Pratt’s Stats, BizComps, The Instituteof Business Appraisers, and Done Deals.For this article the database published byPratt’s Stats was examined to determineif there is a significant differencebetween the pricing multiples when theacquirer is a public company versuswhen the acquirer is a privately heldcompany or an individual.25

Control Premium Study. It is recog-nized that the FactSet Mergerstat Con-trol Premium Study (Control PremiumStudy) also publishes data on businessacquisitions, including a category forfinancial acquisitions. A financial acqui-sition is defined by FactSet Mergerstat asan acquisition where “the acquirer inthe transaction is making the acquisitionfor investment purposes and is not mak-ing the acquisition for strategic busi-ness purposes. Financial buyersfrequently include private equity firms,buyout funds, or any other finance relat-ed company whose principle [sic] line ofbusiness is not directly related to that ofthe target company. Financial buyers aregenerally concerned about their returnon investment, the strength of the man-agement team and the size of the mar-ket.” This would seem to correspondwith the definition of a financial buyerfor purposes of our study. However, thefinancial buyers in the Control PremiumStudy are almost exclusively large privateequity firms such as KKR & Co. ($98

billion under management), BC Part-ners (advising funds totaling over [euro]12 billion) and The Gladstone Com-panies ($1.3 billion invested). Whilesuch buyers may be “financial” as thatterm is defined by the Control PremiumStudy and are not “synergistic,” they havesharply different investment motivationsand risk tolerance, among other signif-icant distinctions, than the typical pri-vately held acquirer, and the pricingmultiples they pay reflect these differinginvestment motivations. These motiva-tions, and not the label of “synergistic”or “financial,” represent the primarypoint of departure for purposes of ouranalysis. Therefore, given that this arti-cle assumes that investment value doesnot equal fair market value, the datapublished by the Control PremiumStudy should not be considered repre-sentative of the typical, fair market val-ue standard used in the valuation of aprivately held subject company.

Data Filtering. The Pratt’s Stats datawas filtered using several different char-acteristics in order to select the transac-tions for analysis. At the time of this study(July 2014) the Pratt’s Stats database con-tained 21,322 transactions; transactionswere eliminated involving companies thatdid not report any revenues, and trans-actions that did not report either the typeof buyer (public or non-public) or the

type of purchase (asset or stock). This left21,160 transactions; in 14,560 cases theacquiring company was a private buyerand in 6,600 cases, the acquirer was apublic company.

The data was further segregated intoasset purchases (total of 15,845 trans-actions) and stock purchases (5,315transactions).26 Each remaining trans-action was analyzed for several pricingmultiples, including market value ofinvested capital (MVIC) to revenues(MVIC/R), MVIC to earnings beforeinterest, taxes, depreciation, and amor-tization (MVIC/EBITDA), and MVICto sel ler’s discret ionary earnings(MVIC/SDE).

Exhibit 1 shows the revenue quartilebreakdowns, the number of transactionsin each grouping, and the median rev-enues of that group.

A review of the Exhibit indicates that,as measured by revenues, the targets


23 This word is “seller” in the original, publishedsource; however, it was confirmed through pri-vate correspondence with the author that thiswas a typographical error, and the correctedstatement is included here.

24 Grabowski, note 21, supra. 25 Retrieved from www.bvmarketdata.com on

7/1/2014. Data was used with BVR’s written per-mission.

26 See Trugman, Understanding Business Valuation:A Practical Guide to Valuing Small to Medium-Sized Businesses, 4th Ed. (AICPA, 2012), “Smallbusinesses typically are sold as asset sales asopposed to stock sales. An asset sale is a transac-tion where only certain assets (and maybe liabili-ties) are transferred to a purchaser who will effec-tively become the new owner of the business.

More often than not, only the operating assets(the assets that are needed to conduct the busi-ness operations) of the business are transferredto the buyer. This type of transaction is commonfor smaller businesses. It is also very differentfrom a stock sale, which is typical of larger busi-ness transactions. In a stock sale, the stock (allassets and liabilities) is transferred to the buyer.This transfer represents the entire equity of thecompany.” (Page 350, emphasis in the original.)

27 Pratt’s Stats FAQs, available online athttp://www.bvmarketdata.com

28 Id., citing Trugman, note 26, supra, page 223. 29 Id., citing Gabehart and Brinkley, The Business

Valuation Book: Proven Strategies for Measuringa Company’s Value, (AMACOM, 2002), pages198-199.

EXHIBIT 1Data Analysis by Quartile

ASSET PURCHASES ($ IN 000)Private Buyers Public Buyers

Quartile RevenueRange Count Median

RevenueRange Count Median

1st Quartile Up to $217 3,434 $136 Up to $3,750 528 $1,4012nd Quartile $217 - $433 3,433 $307 $3,750 -

$12,719 527 $7,196

3rd Quartile $433 - $937 3,434 $615 $12,719 -$46,327 527 $23,415

4th Quartile $937 -$1,542,779 3,433 $1,756 $46,327 -

$5,177,000 529 $106,334

STOCK PURCHASES ($ IN 000)Private Buyers Public Buyers

Quartile RevenueRange Count Median

RevenueRange Count Median

1st Quartile Up to $789 207 $427 Up to $4,051 1,123 $1,3842nd Quartile $789 -

$1,916 207 $1,213 $4,051 -$13,355 1,122 $7,443

3rd Quartile $1,916 -$5,000 207 $2,981 $13,355 -

$48,514 1,122 $23,634

4th Quartile $5,000 -$940,000 205 $10,389 $48,514 -

$17,178,097 1,122 $111,897

turn, may force the analyst to rely onasset transactions instead. Since relianceon the assumption of which assets/lia-bilities to adjust for is thus required, thismay have the effect of reducing the ana-lyst’s confidence in the indication of val-ue derived from the market approach,giving it less weight in the final conclu-sion.

Asset PurchasesExhibit 2 illustrates the pricing multi-ples of each group for asset purchasetransactions. The table in the exhibitspresents the data for public buyers intwo categories. The first category isorganized by the revenue quartiles of

the target companies acquired by allpublic buyers. The second groupingshows only those public companyacquisitions that match the revenuequartiles of the companies acquired bythe private buyers; this will facilitatecomparison of public buyer transac-tions with private buyer transactions. Ifcomparisons of private buyers of theassets of companies with sales between$433,000 to $937,000 (third quartile inExhibit 2) are made with the third quar-tile of public buyers (target companieswith sales of $12.7 million to $46.3 mil-lion), it may distort the interpretation ofthe results, since size matters.31 “Oneof the most important indicators ofcomparability is size.”32

Also, a typical selection criterion forcomparable transactions is revenuerange; so, as a practical matter, trans-actions of companies with similar rev-

enues (regardless of the nature of theacquirer) are combined by the analystfor the market approach analysis.

For purposes of comparison, this dis-cussion will focus on the data using therevenue quartiles of private buyers,unless otherwise noted.

Note also that not all transactionsreport multiples for all metrics, thus thereduced counts for the multiples thatare not based on revenues.33

Exhibit 2 begins to show the sepa-ration of pricing multiples among pri-vate buyers as compared to publicbuyers. For all categories, the medianpricing multiples paid by public acquir-ers are higher, often many times high-er, than those paid by private acquirers.For example, the median revenue pric-ing multiple paid by public acquirersfor companies with revenues between$433,000 and $937,000 was 2.17, more


assumptions made regarding whichassets and liabilities are included in thepricing multiple.

Competing Objectives. Even in caseswhere the asset allocation is given, thereliability of these amounts may be inquestion due to the competing objectivesof the buyer and seller in the negotia-tions that resulted in the asset allocation.

In an asset sale, the buyer and theseller have competing objectives when itcomes to agreeing on the asset alloca-tion. Certain assets must be depreciat-ed by the buyer over many years,whereas others are deductible in the yearacquired. Which treatment the buyerwould prefer may change depending onwhether the buyer wants to show lowerincome in order to reduce taxes, or high-er income to please shareholders. Con-versely, for the seller, the sale of certainassets will be treated as ordinary income,and others as capital gain.

This frequently puts the buyer’s andseller’s preferred price allocation at oddswith one another, with the final resultbeing influenced perhaps more by nego-tiations than the actual market valuesof the individual assets. Thus, even inthose instances where the purchase allo-cation is reported, its reliability may bequestionable.

Depending on the screening criteriafor selecting transactions of comparablecompanies (revenue range, industry, andperhaps financial metrics such as prof-itability), the number of available trans-actions may be limited for a particularsubgroup (e.g., private buyers of stockor public buyers of assets). Therefore, theresulting selection may include onlytransactions of private companies thatmade asset purchases; this limitationmay not provide a sufficient number ofpricing multiples for reliable applica-tion of the market approach.

[U]nless there are at least 5 or 6 trans-actions in the sample of the market,the sample should not be regardedas representative of the market. Insuch a situation [no] appraisalmethod that is based on actual trans-action data should be used. The needfor a large enough number of trans-actions to reflect the market appliesto any appraisal method using guide-line transactions.30

This may have significance in theapplication of the market approach in

any given assignment. Since the apprais-er is typically asked to value a compa-ny’s equity (stock) it is preferable to usestock transactions as comparables. Fora particular subject company’s size rangethis may result in a limited number ofstock purchases for analysis. This, in


30 “Introduction to the Direct Market Data Methodof Valuing Mid-Size and Smaller Closely HeldBusinesses,” (Institute of Business Appraisers,Publication P-409, 2005), pages I-11.

31 Pratt, The Market Approach to ValuingBusinesses, 2nd Ed., note 13, supra, page 252.

32 Hitchner, Financial Valuation, 3rd Ed., note 12,supra, page 277.

33 Note no comparisons are made of the SDE multi-ple because none of the public buyer quartilesreported a sufficient number of SDE multiples toallow any meaningful analysis.

EXHIBIT 2Pricing Multiples

ASSET PURCHASES ($ IN 000)

Private BuyersUp to$217 Count

$217 - $433 Count

$433 - $937 Count

$937 - $1,542,779 Count

MVIC/R 0.6 3,434 0.44 3,433 0.42 3,434 0.4 3,433MVIC/EBITDA 2.3 2,159 2.95 2,258 3.69 2,369 4.6 2,534MVIC/SDE 1.76 1,834 2.06 1,936 2.3 2,190 2.78 2,409

Public BuyersUp to$217 Count

$217 - $433 Count

$433 - $937 Count

$937 - $1,542,779 Count

MVIC/R 26.54 60 3.6 48 2.17 82 0.91 1,907MVIC/EBITDA 9.1 10 12.48 12 7.88 24 8.4 1,020MVIC/SDE n/a - n/a - n/a - 7.02 28

Public BuyersUp to$3,750 Count

$3,750 - $12,719 Count

$12,719 -$46,327 Count

$46,327 -$5,177,000 Count

MVIC/R 1.99 528 1.08 527 0.79 527 0.68 529MVIC/EBITDA 9.49 206 8.41 284 7.84 305 8.58 277MVIC/SDE 239.14 4 4.6 9 6.01 8 9.49 8

EXHIBIT 5Entire Public Asset Purchase Database ($000)

0

2

4

6

8

10

Up to $3,750

MVIC/R MVIC/EBITDA

$3,750 – $12,719 $12,719 – $46,327 $46,327 – $5,177,000

EXHIBIT 4Public Buyer Revenue Multiples for Asset Purchases ($000)

0

5

10

15

20

25

30

Up to $217

MVIC/R MVIC/EBITDA

$217 – $433 $433 – $937 $937 – $1,542,779

EXHIBIT 3Private Buyer Revenue Multiples for Asset Purchases ($000)

0

1

2

3

4

5

Up to $217

MVIC/R MVIC/EBITDA

$217 – $433 $433 – $937 $937 – $1,542,779

MVIC/SDE

EXHIBIT 6Pricing Multiples for Stock Purchases

STOCK PURCHASES ($ IN 000)

Private BuyersUp to$789 Count

$789 -$1,916 Count

$1,916 -$5,000 Count

$5,000 -$940,000 Count

MVIC/R 0.52 207 0.54 207 0.58 207 0.67 205MVIC/EBITDA 4.85 133 6.12 157 7 157 6.67 170MVIC/SDE 2.63 133 2.77 154 3.44 141 4.65 130

Public BuyersUp to$789 Count

$789 -$1,916 Count

$1,916 -$5,000 Count

$5,000 -$940,000 Count

MVIC/R 26.52 373 3.08 324 1.76 601 1.18 2,922MVIC/EBITDA 55.17 61 15.37 112 11.95 276 9.45 1,773MVIC/SDE 11.07 1 3.03 2 9.27 7 5.48 33

Public BuyersUp to$4,051 Count

$4,051 -$13,355 Count

$13,355 -$48,514 Count

$48,514 -$17,178,097 Count

MVIC/R 3.61 1,123 1.54 1,122 1.14 1,122 0.97 1,122MVIC/EBITDA 15.21 370 10.08 585 8.92 680 9.38 743MVIC/SDE 5.89 8 5.32 13 4.54 7 8.55 21

to be typically transferred in such atransaction.

Exhibit 6 presents the pricing mul-tiples for stock purchases. As before,public buyer pricing multiples aresignificantly higher across all sizegroups than for private buyers. Alsoas before, public companies acquirelarger private companies than pri-vate buyers do.

Exhibit 7 shows the trend of pricingmultiples for private companies mak-ing stock purchases.

In this case, the revenue pricing mul-tiple increases as size increases, from0.52x for the first revenue quartile to0.67x for the largest. Similarly, the SDEmultiple increases across the range. TheEBITDA multiple, however, grows fromthe first quartile through the third, declin-ing by about 5% in the last quartile.

Exhibit 8 shows the pricing multi-ples of public company acquisitionsusing the revenue quartiles of the privatetransactions.

The pricing multiples of the full pop-ulation of public buyers display anessentially similar pattern, although themagnitude of the amounts is much low-er in the first three quartiles.

As seen in Exhibit 8, when the pub-lic company acquisitions are groupedby public company revenue quartiles(each with more than 200 transactions),the data shows a declining pattern for allfour quartiles of the revenue multiple,and for the first three quartiles of theEBITDA multiple. This pattern is near-ly identical to that of the full popula-tion of public acquisitions of assets.

Comparison of MultiplesRegardless of the directions and slopesof the individual patterns of the pricingmultiples observed, what is clear is thatthe multiples for companies acquiredby public companies are greater thanthose for companies acquired by pri-vate companies. This is true for bothasset purchases and stock purchases.

As stated earlier, the analyst attemptsto find market transactions of compa-nies of similar revenue size to the subjectcompany in order to enhance the com-parability of the transactions to the analy-sis. In order to compare acquisitions ofsimilar-sized companies, data will be pre-sented for both public and private acquir-ers using the revenue quartiles of private

buyers. In this manner, pricing multiplesof target companies of similar size will bematched, as the analyst would do duringthe screening process.

The charts in Exhibit 9 demonstratethat, for both revenue and EBITDA mul-tiples, public companies pay higher mul-tiples for private companies of similarsize than private buyers would.34

Thus, the transactions involving pri-vate company buyers appear to be a sep-arate population of data from thosetransactions involving public companybuyers. Accordingly, the two populationsshould not be mixed when applying themarket approach; if the standard of val-ue being sought is a synergistic value,transactions of public buyers may be themost appropriate set of data to rely on.If, however, a financial, non-synergistic,value is the objective, transactions ofprivate buyers is likely the best data set.The two distinct populations of data aretherefore probably mutually exclusive inthis regard.

Dispersion of DataThe analysis thus far clearly shows thehigher multiples paid by public acquir-


than five times the multiple of 0.42paid by private acquirers for companiesin the same revenue range. For thecompanies represented in the fourthquartile, the public company revenuemultiple of 0.91x is 2.3x the privatebuyer multiple of 0.40x.

Exhibit 2 also demonstrates that, forprivate buyers of assets, as the size ofthe acquired company grows, marked-ly higher multiples are paid for EBITDAand SDE. However, the revenues multi-ple remains essentially unchanged,declining almost imperceptibly for allbut the group of the smallest compa-nies (those in the first quartile), asshown in Exhibit 3:

However, for public buyers, the pat-tern is somewhat different, as illustrat-ed in Exhibit 4:

For public buyers, while the revenuemultiples follow the same general pat-tern as for the private acquirers, thedecline from quartile to quartile is quitesharp initially. Although the decline inthe subsequent quartiles is much moregradual, it is nevertheless more pro-nounced than for private acquirers ofasset purchases. From the first quartileto the second, the pricing multiple dropsby 46% (from 1.99x to 1.08x), then by27% to 0.79x and finally by 14% in thefourth quartile.

In contrast, revenue multiples for pri-vate buyers of asset transact ionsdecreased by 27% from the first quartileto the second, and then by less than 5%for the third and fourth quartiles.

Sample Size. For public buyers, thiserratic pattern of observed EBITDAmultiples for asset purchases may bedue to the sample size being much morerobust for stock purchases than for assetpurchases. For asset purchases involvingpublic acquirers, only the largest rev-enue category, with 1,020 transactions,had a sample size larger than two dozen.However, the general pattern observedabove is confirmed when the entire data-base for public acquirers is examined,using the public buyer revenue quar-tiles, so that each EBITDA group has atleast 370 transactions.

As shown in Exhibit 5, except forthe first quartile, a similar patternemerges as above, wherein the multi-ples decline over the last three quar-tiles. For asset purchases (for bothprivate and public buyers) the gener-al pattern of revenue multiples holdstrue in that the multiples decline overthe last three quartiles, although themultiples for the public acquirersdecline more sharply. However, theEBITDA multiples behave somewhatdifferently. For private buyers, EBITDAmultiples grow as the size of the targetcompanies grow. Conversely, across thepopulation of public buyers of assets,

the EBITDA multiples generally dropacross the first three quartiles, and onlygrow for those companies in the high-est quartile.

Stock PurchasesAs stated earlier, since appraisers aretypically asked to value the equity ofthe company (that is, an assumedstock sale), it is generally preferable tovalue the subject company by directreference to stock sale pricing multi-ples. If asset sale pricing multiples areused, they must then be adjusted toaccount for those assets not assumed


34 Note that the two charts for the MVIC/R multi-ples do not show the data for the first revenuequartile. This is because in this revenue range thepublic acquirer multiples are so much higher thanthe private buyer multiples that the scale of thechart is distorted, making the private buyer multi-ples almost imperceptibly small.

EXHIBIT 7Private Company Pricing Multiples Trend for Stock Purchases ($000)

012345678

Up to $789

MVIC/R MVIC/EBITDA MVIC/SDE

$789 – $1,916 $1,916 – $5,000 $5,000 – $940,000

EXHIBIT 8Public Acquisition Multiples Using Private Buyer Quartilesfor Stock Purchases ($000)

0

10

20

30

40

50

60

0

5

10

15

20

Up to $789MVIC/R MVIC/EBITDA

$789 – $1,916 $1,916 – $5,000 $5,000 – $940,000

Up to $4,051MVIC/R MVIC/EBITDA

$4,051 – $13,355 $13,355 – $48,514 $48,514 – $17,178,097

EXHIBIT 9Private Versus Public Multiples ($000)

Private Public

–

2.00

4.00

6.00

8.00

10.00

12.00

14.00

–

.50

1.00

1.50

2.00

2.50

3.00

3.50

–

.50

1.00

1.50

2.00

2.50

3.00

3.504.00

–

10.00

20.00

30.00

40.00

50.00

60.00

$217 – $433 $433 – $937 $937 – $1,542,779

$789 – $1,916 $1,916 – $5,000 $5,000 – $940,000

Up to $217 $217 – $433 $433 – $937 $937 – $1,542,779

Up to $789 $789 – $1,916 $1,196 – $5,000 $5,000 – $940,000

Private Public

Private Public Private Public

MVIC/R ($000)Asset Purchases

MVIC/R ($000)Stock Purchases

Asset PurchasesMVIC/EBITDA ($000)MVIC/EBITDA ($000)

Stock Purchases

Using Public Buyer Quartiles

coefficients of variation for revenuesmultiples for public buyers may be dueto the expectation of synergies, where-in the public acquirer is paying a mul-tiple based on its internal expectationsof the synergistic level of revenues forthe combined entity. This would weak-en the link between the target compa-ny’s historical revenues and the pricepaid, especially when acquiring small-er companies, and lead to higher dis-persion of the data.

The MVIC/EBITDA multiples forasset purchases, with only a few excep-tions, have coefficients of variation thatare lower for public acquirers. Note alsothat, in almost all cases, the coefficientsof variation for EBITDA multiples arehigher than for revenues multiples, indi-cating a weaker link between MVIC andEBITDA.

For stock purchases, the coefficientsof variation for MVIC/Rev multiples arelower for private buyers than for public

buyers, so that for both stock and assetpurchases, coefficients of variation arelower for private buyers. ForMVIC/EBITDA multiples, the coeffi-cients of variation are generally lowerfor private buyers, which is the oppositeof what is observed for asset multiples.

Thus, for MVIC/Rev multiples, andfor both asset purchases and stock pur-chases, the data from private companybuyers produces a lower coefficient ofvariation, indicating that private com-

pany transactions are the “better” indi-cator of value. “Generally, the tighter therange of the data points, the less roomfor judgmental error in deciding on theappropriate multiple for the subjectcompany relative to the guideline com-panies.”38

To summarize, for revenues multi-ples, private buyer transactions producelower coefficients of variation than pub-lic buyers, for both asset and stock pur-chases. For EBITDA multiples, theevidence is murkier. For asset purchas-es, public buyer transactions result inlower coefficients of variation, while theopposite is true for stock purchases.However, overall, the coefficients of vari-


ers as compared to private acquirers.What has not been shown is the dis-persion of the data. This is an importantmeasurement because it provides insightinto the reliability of the data for use inthe market approach.

We measure the degree of disper-sion by a statistic called the coeffi-cient of variation (coefficients ofvariation), which is defined as thestandard deviation divided by themean.… When market value mul-tiples among companies in anindustry are tightly clustered, thissuggest that these are the multi-ples that the market pays mostattention to in pricing companiesand stocks in that industry.… Thelower the coefficient of variation,the lower the dispersion of the datapoints, and the better the valua-tion multiple is as an indicator ofvalue. When market value multi-ples among companies in an indus-tr y are t ight ly clustered, thissuggest that these are the multi-ples that the market pays mostattention to in pricing companiesand stock in that industry.35

Although a low coefficient of varia-tion indicates lower dispersion, the

source cited above offers no guidance onwhat specific value for a coefficient ofvariation is “good” or “bad;” coefficientsof variation can be examined and com-pared only in relative terms.

For this portion of the analysis eachcategory of data was segregated into 20equal-sized groups, for enhanced gran-ularity. Exhibit 10 shows the coefficientsof variation for the different categoriesexamined.

Exhibit 11 shows the coefficientsof variations for both asset purchaseand stock purchase transactions, byboth private and public buyers, andfor both revenues and EBITDA mul-tiples, across 20 equal-sized groups.Group 1 contains the target companieswith the lowest level of revenues, andGroup 20 contains the target compa-nies with the highest level of rev-enues.36

The relationships among the num-bers are more easily interpreted and bet-ter illustrated visually in the charts inExhibits 11 and 12.37

The MVIC/Rev multiples for assetpurchases have coefficients of varia-tion that are lower, across almost allgroups, for private company acquirersthan for public acquirers, with excep-tions occurring within the groups oflarger target companies. The higher


EXHIBIT 10Coefficients of Variation

Coefficient of Variation (Standard Deviation divided by the mean)Asset Purchases Stock Purchases

Group #

MVIC/Rev MVIC/EBITDA MVIC/Rev MVIC/EBITDAPrivate Public Private Public Private Public Private Public

1 0.80 3.11 1.69 2.00 0.58 2.74 1.34 3.702 0.89 1.62 7.54 1.63 0.62 2.76 1.50 4.833 0.62 2.28 4.31 3.12 0.47 2.70 1.80 3.544 0.73 1.13 8.47 1.05 0.54 1.86 1.42 6.245 0.87 4.26 4.55 1.12 1.09 2.77 3.31 1.466 0.58 1.72 8.30 1.70 0.51 5.36 1.15 5.477 0.78 1.14 3.19 3.73 0.52 1.01 2.14 2.698 1.03 1.11 2.83 2.75 0.56 1.82 2.26 2.349 0.66 1.00 7.45 0.92 0.53 1.65 1.84 2.3710 1.00 1.47 5.38 5.14 0.31 1.58 2.30 4.2011 0.70 0.88 3.43 1.54 0.57 1.28 1.14 2.0112 0.83 1.05 7.89 1.80 0.87 1.93 1.15 1.5113 0.78 1.66 4.05 2.21 0.46 1.62 0.64 5.3214 0.86 1.09 8.38 0.73 1.03 1.31 1.16 2.1815 0.86 0.95 4.71 1.20 0.56 1.17 0.87 2.8916 1.01 0.95 1.39 1.89 0.52 1.64 0.64 1.5617 1.06 2.03 2.64 0.79 0.70 1.28 1.01 3.9918 1.35 1.05 3.74 0.86 0.89 1.07 0.99 1.3419 1.16 1.10 2.96 1.15 0.58 1.24 1.21 1.7420 1.32 1.10 0.96 1.82 0.90 1.24 0.88 0.83

EXHIBIT 11Illustration of MVIC Multiples

0 5 10 15 20 0 5 10 15 20

Group #Priv - Rev Pub - Rev

Group #Priv - EBITDA Pub - EBITDA

–

.501.001.502.002.503.003.504.004.50

–1.002.003.004.005.006.007.008.009.00

MVIC/Rev CoVarAsset Purchases

MVIC/EBITDA CoVarAsset Purchases

EXHIBIT 12Stock Purchase Variation Coefficients

-

2.00

4.00

6.00

8.00

10.00

0 5 10 15 20Group #

Priv - Rev Pub - Rev Pub - Rev

Group #

Priv - EBITDA Pub - EBITDA Pub - EBITDA

-1.002.003.004.005.006.007.00

0 5 10 15 20

MVIC/Rev CoVar MVIC/EBITDA CoVar

EXHIBIT 13Asset and Stock Purchase Subgroup Data

-1.002.003.004.005.006.007.008.009.00

0 2 4 6 8 10 12 14 16 18 20Group #

Group #

Priv - Rev Pub - Rev Priv - EBITDA Pub - EBITDA

Priv - Rev Pub - Rev Priv - EBITDA Pub - EBITDA

–

1.00

2.00

3.00

4.00

5.00

6.00

7.00

0 5 10 15 20

Stock Purchases CoVar

Asset Purchases CoVar

35 Pratt, note 13 supra, pages 131 and 139. 36 Note that one extreme outlier was eliminated

from Group 18 in the EBITDA multiples for assetpurchases by private companies in order that thescale not be so large as to mask the pattern ofthe other metrics.

37 Note that the data points in Exhibit 12 labeled“Pub-Rev*” and “Pub-EBITDA*” are for publicbuyer transactions using private company rev-enue groupings. These supplemental groupingsresult in the same interpretation of the datadescribed in the article. Similar data is not pre-sented for asset purchases because it wouldresult in only one fewer transaction per group formost of the groups, and therefore would not addto the analysis.

38 Pratt, note 5, supra, page 292.

includes both inpatient enterpris-es, such as hospitals, skilled nurs-ing facilities, etc., and outpatiententerprises, such as physician prac-tices, ambulatory surgery centers,etc., which have very different prof-itability profiles); or,

(2) Healthcare related public buyersmay have some sort of market lever-age over healthcare related privatebuyers, e.g., better access to capital,larger geographic scope, higheremployment compensation pack-ages, etc . , that a l low them toacquire the more profitable enter-prises, in comparison to the enter-prises purchased by private buyers.

However, further investigation andanalysis is warranted in order todetermine whether these prelimi-nary assertions are valid.40

Of course, such factors may be atplay in other industries as well; outside

expertise was sought only in the healthcare industry because of the apparentanomaly.

As stated previously, however, evenan instance in which the premiumseems to be acceptably small does notspeak to the motivations and objec-tives of the acquiring companies, andwhether those transactions are com-parable where the standard of value isfair market value; that is, if the multi-ples seem “right” but for the wrongreasons, they may not be valid as com-parables.

Purchase Price Allocation by IndustryAs mentioned earlier, approximately44% of the transactions in the Pratt’sStats database present the allocation ofthe purchase price among the assets asagreed to by the parties. This informa-tion removes some of the guesswork indetermining, specifically, which assetschanged hands in the transaction.

However, these transactions are notdistributed evenly throughout the data-base. Ten of the two-digit SIC codes rep-resent a combined 69% of the transactionsthat report the asset allocations:

% of Total SIC Asset Allocation CODE Transactions 07 4.23% 50 3.13% 54 3.17% 55 2.99% 58 21.05% 59 8.75% 72 9.14% 73 8.66% 75 4.19% 80 3.79%

———–––––––––––––——

69.11% Thus, of the 77 two-digit SIC codes

found in the database, 69% of the trans-actions reporting asset allocations arein these ten SIC codes; this means that,unless the subject company operates inone of these ten SIC codes, the analystmay not be aided by the reported assetallocations. However, as discussed pre-viously, even in those instances whereasset allocations are available, theyshould be taken with a grain of salt.

ConclusionThere is a wealth of information avail-able in Pratt’s Stats and other similardatabases of transactions, that can beused in applying the market approach.However, it is the responsibility of theanalyst to fully understand the data, itsdevelopment, and just as importantly,its relevance to the assignment at hand.

The analyst must take care to matchthe market-based, observable empiricaldata to the characteristics of the sub-ject company as closely as possible. Thisincludes factors such as the subject com-pany’s industry, size, and profitability,as well as the valuation assignment date,purpose, and standard of value. For themarket approach, if the synergistic val-ue of a subject company is being sought,the analyst should take care to includeonly transactions that produce a syn-ergistic pricing multiple. Likewise, if fairmarket value is the standard of valuebeing sought (assuming that fair marketvalue is not equivalent to investment orsynergistic value for the particularengagement) then synergistic transac-tions should be excluded. �


ation for EBITDA transactions showmuch higher variability than for rev-enue multiples.

Asset and Stock Purchases. Exhibit13 shows the data for all four asset pur-chase subgroups and all four stock pur-chases subgroups, on the same scale forthe x-axis, to provide a better visual com-parison of the coefficients of variation:

The higher coefficients of variationfor the EBITDA multiples as comparedto revenues multiples may be due to thepresence of expected synergies oreconomies of scale that occur below therevenues line, the magnitude of whichwould be expected to vary from case tocase. That is, in addition to potentialrevenues synergies, the acquirer is like-ly expecting an even greater degree ofsynergies in reducing cost of sales andoverheads, resulting in a greater expect-ed synergistic boost to EBITDA than torevenues. This would weaken the linkbetween the target’s historical EBITDAand the price willing to be paid by theacquirer, and to a greater degree thanthe link with revenues. As stated earli-er, acquisitions made by private buyerslikely include some degree of anticipat-ed synergies, although at a much lowerlevel than for public acquirers.

The same general pattern is apparentwith stock purchases, in that the coeffi-cients of variation of revenues multi-ples for private buyers are generallylower than for public buyers. However,here the coefficients of variation ofEBITDA multiples are higher for publicbuyers than for private buyers.

Industry AnalysisThe data was also analyzed by examin-ing those two-digit SIC codes for whichthere were at least ten transactions ineach of the four transaction categories(private-asset, private-stock, public-assetand public-stock) and each of the pric-ing mult iples (MVIC/Rev andMVIC/EBITDA). 12 SIC codes metthese criteria.

In Exhibit 14, the “public buyer pre-mium” is the factor by which the medi-an public buyer pricing multiple exceedsthe median private buyer multiple, e.g.,for SIC 27, the median public companyMVIC/Rev multiple of 2.00x is 3.57times the median private buyer multipleof 0.56x.39

For the 24 premiums calculated inExhibit 14, the public buyer multiplesfor asset purchases exceed the privatebuyer multiples by at least 10% (“pre-mium” of 1.10) in all but five instances,including one instance where the pub-lic premium is negative (EBIDTA mul-tiple for SIC 80). In only one industry(SIC 50: wholesale trade—durablegoods) are both the MVIC/Rev and theMVIC/EBITDA multiples within thisarbitrarily selected threshold. Theimpact of what appear to be small pre-miums should not be underestimated.For example, the MVIC/Rev for SIC 39(miscellaneous manufacturing) showsa premium of “only” 14%. But thismeans that use of the public buyer mul-tiple in a situation where the privatebuyer multiple should apply would resultin an overvaluation of 14%, other thingsbeing equal. This is a significant (andavoidable) error.

Similar results are observed for theEBITDA pricing multiples as illustratedin Exhibit 15. Here, in only two instances

do the public company multiples notexceed the private company multiplesby at least 10%, including one in whichthe public premium is negative (again,the EBIDTA multiple for SIC 80).

Note also that three of the combined48 premium calculations show the pub-lic multiple being more than 10% belowthe private company multiples (nega-tive premiums), and that two of thesethree are in SIC 80 (health services). Inseeking to determine why this may betrue for SIC 80, Health Capital Consul-tants (HCC) was contacted, nationallyrecognized experts in healthcare eco-nomic and financial consulting. HCCresponded:

Preliminary, possible explanationsfor why in SIC 80, the Price to EBIT-DA multiple is higher for privatebuyers than it is for public buyers,include:

(1) In the healthcare industry, pub-lic buyers may be purchasing dif-ferent types of enterprises thanprivate buyers, (note that, SIC 80


39 Due to copyright limitations, the actual multiplesare not being published, only the multiplier.

40 Private correspondence with Matthew Wagner,MBA, CFA, 9/25/2014, emphasis in the original.

EXHIBIT 14Public Buyer Premium Factor

Public Buyer PremiumMedian Asset Purchases

SIC Buyer Revenue MVIC/Rev MVIC/EBITDA27 Private 434,92827 Public 5,755,778 3.57 2.2834 Private 1,132,07634 Public 17,391,531 1.08 1.3635 Private 1,024,41435 Public 11,441,016 0.98 1.3436 Private 1,522,21936 Public 7,903,315 1.48 1.2339 Private 524,71139 Public 7,004,274 1.14 1.4342 Private 492,80942 Public 7,020,557 1.46 1.9450 Private 876,32950 Public 949,079 1.01 1.0458 Private 352,47058 Public 10,119,611 1.88 3.1959 Private 385,53259 Public 5,497,760 1.17 2.1473 Private 323,72273 Public 4,554,658 2.17 2.6380 Private 740,86780 Public 3,187,709 1.69 0.6287 Private 448,31887 Public 6,207,510 1.34 2.10

EXHIBIT 15EBITDA Pricing Multiples

Public Buyer PremiumMedian Stock Purchases

SIC Buyer Revenue MVIC/Rev MVIC/EBITDA27 Private 434,92827 Public 5,755,778 3.04 1.9434 Private 1,132,07634 Public 17,391,531 1.29 1.5135 Private 1,024,41435 Public 11,441,016 1.67 1.2736 Private 1,522,21936 Public 7,903,315 1.94 1.3539 Private 524,71139 Public 7,004,274 1.38 0.8742 Private 492,80942 Public 7,020,557 1.38 1.3550 Private 876,32950 Public 949,079 1.22 1.3158 Private 352,47058 Public 10,119,611 2.28 1.0959 Private 385,53259 Public 5,497,760 5.04 2.5073 Private 323,72273 Public 4,554,658 4.12 2.6980 Private 740,86780 Public 3,187,709 2.08 0.3587 Private 448,31887 Public 6,207,510 2.00 1.98

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