chiriac bogdan business valuation using multiples

8/13/2019 Chiriac Bogdan Business Valuation Using Multiples

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Business Valuation using Multiples

- Methods of adjusting multiples taken from a

developed economy: case study Romania -

Author: BOGDAN CHIRIAC

Coordinator: Prof.univ.PhD. ANAMARIA CIOBANU

There was a double motivation in choosing this subject. Firstly, a scientific one,

professional, generated by the difficulty met when choosing a multiple for equity

valuation. To this we add the attempt of determining the necessary corrections when

taking a multiple from a developed economy, this action being hardened by the lack of

information and comparables on the national market.

Secondly, there was also a subjective motivation- the desire to research an area of

personal interest, in which I wish to perfect, currently following a career in this area.

Starting from these considerations, we have established the following objectives:

Determining, for Romania, at the beginning of 2012, what adjustmentsneed to be made to multiples taken from a developed economy,

specifically the U.S one

Computing synthetic multiples for Romania: Price earning ratio (PER),Price to sale (P/S) and Price to book value (P/B)

Establishing the necessary corrections in the case of industry belongingThe purpose of this paper is to create a framework through which a valuator can,

at any moment, determine the necessary adjustments for a multiple taken from a

developed market.

Based on the objectives stated above, we have structured this paper in three

chapters.

The first part, intitled Specialized studies, we discuss the literature and the

empiric studies related to the topic at hand.


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The relative valuation of a company assumes following some stepts: choosing the

comparable peers and selecting valuation relevant multiples. However there are three

considerations that should be taken into account regarding comparable firms in an

emergent economy:1:

a. The size of the sampleb. Any differences between companiesc. Liquidity issues

When dealing with companies in an emergent market, finding comparables is

difficult because of few transactions with similar firms. According to Anghel Ion2, the

lack of information and transactions forces analysts from these countries to use a

developed country as reference (like the U.S one). However, borrowing multiples from a

developed country without correcting them for country risc is an irelevant action.

The need for adjusting these multiples is obvious and sustained by empiric

studies. Nonetheless, this method has its difficulties such as what multiple to choose, the

time frame for which the correction coefficient should be determined, determining the

correction coefficient. Pereiro also claims the multiples adjusment for emergent market

liquidity.

The first economists who researched relative valuation focused on PER, as Beaver

and Morse did in 1978. They tried to determine the behavior of PER. Boatsman and

Baskin (1981) determine the accuracy of PER based on two sets of comparables from the

same industry. Alford (1992) states that selecting comparable firms based on industry

membership is efficient. However, selecting comparables regarding on risk and earnings

growth, used together has the same efficency.

In a general study, Kaplan and Ruback (1995) compared the valuation

performance of DCF against relative valuation. They concluded that both DCF valuation

and EBITDA multiple based valuation supply the same exact estimations.

1A. Damodaran, Volatility Rules: Valuing Emerging market companies, pe

http://pages.stern.nyu.edu/~adamodar/pdfiles/DSV2/Ch16.pdf, Stern School of Business, 2009,2Anghel, Ion; Stan, Sorin V.,Evaluarea ntreprinderii, Editura IROVAL, Bucureti, 2007


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Nissim and Thomas (2001) show that multiples based on forward earnings

(forward earning multiples) supply more accurate valuation than hystory based multiples.

The same conclusions are drawn by Kim and Ritter (1999) and Lie and Lie (2002). Yoo

(2006) shows that the P/S multiple has the weakest accuracy in valuation.

The second component in estimating market value represents the identification of

similar companies. This is a rather difficult task as two companies cannot be identical and

firms from the same industry can differ.

There are several factors that should be taken intro account when selecting peer

companies, like: the size of the company, growth rate, firm risk, capital structure, size,

industry, transaction date, amount of capital traded. DragoIoan Mnjin(2007) claims

that on the Romanian capital market, one selection criteria for comparables that can lead

to better valuation accuracy is the return on equity (ROE)3.

The second part, Theoretical foundation, captures the theoretical methodology of

multiples and of comparables selection.

There are two parts of relative valuation4. Firstly, when valuating assets, their

prices need to be standardized. This is usually done by converting prices into multiples.

Secondly, one must find similar companies, which is a rather difficult task. Under these

circumstances, the question of how the differences between firms can be dealt with

becomes a key one.

Steps in applying market valuation (relative)5:

Step 1: indentifying similar transactions of comparable companies, undertaken in

the same conditions with those defining the company under valuation

Step 2: analyzing relevant financial indicators in order to determine the financial

situation of the peers. These indicators oftenly are: gross and net profit, cash flow, sales,

assets, EBITA, etc.

3DragoIoan Mnjin,Evaluarea prin multipli a aciunilor de pe piaa de capital din Romnia,REPEC,

20094Op. cit5Dalina Dumitrescu, Victor Dragot, Anamaria Ciobanu,Evaluarea ntreprinderilor, Ediia 2-a, Editura

Economic, 2002, p. 163


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Step 3: selecting the relevant multiple. Its adequate to compute a mean or median

of the prices investors are willing to pay for the comparable firms. Thus a price for the

valuated company will be obtained6.

Step 4: Valuation

Multiples can be divided intro capital multiples (PER, PERg, PBV, P/S, P/CF

gestiune, P/Asset) or intro company multiples (Firm value/EBITDA, FV/CF, FV/S).

The third and last part,Methods of adjusting multiples taken from a developed

economy : case for Romania, has a pronounced applicative nature. Its a study case of the

Romanian economy that tries to determine both the necessary adjustments for country

risk but also the adjustments for industry belonging.

We used three approaches: sovereign bond yield, market multiples ratio and

multiple regression.

Our analysis is based on a sample of data gathered from Bucharest Stock

Exchange website and from the NYSE one. We selected companies listed both on

NASDAQ and RASDAQ, these sample being used exclusivelly in the second part of the

study.

The initial sample was made up of 4973 companies. From which 73 were

Romanian companies and 4900 U.S companies. We also used Yahoo Finance and

Markettroler to complete our data. This first sample was then adjusted, and based on the

analysis performed, certain companies were excluded.

This paper addresses the problem of building a methodology for adjusment taking

intro account country risk and industry risk. In order to to so, we analysed two markets:

the Romanian one as an emergent market and the U.S one as a developed market. The

analysis was carried as at february 2012.

Using the yield to maturity bond spread the correction coefficient of a U.S based

multiple should be 34.8%.

The second approach supports the construction of a correction coefficient using

the multiples median of the emergent and developed economy. This method describes

the relative difference between investors perceptions from the two markets and

6Simon Z. Benninga, Oded H. Sarig, Corporate Finance: A valuation Approach, McGraw- Hill, New

York, 1997


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illustrates the difference for country risk (companies from a stable market should have

higher value multiples). This ratio incorporates other firm specific risks like corporate

governance differences7. This reason is why such an approach should offer better results

than the previous one.

Multiples adjusments:

PER P/B P/S

Adjusment/correction 57.43% 31.76% 32.10%

The above mentioned adjusments are derived from a practical experience.

However they can be subject to theoretic criticism. This is why we will do regression

analysis which will show what adjusments are necessary.

PER = 14.86 + 4.19 Payout Ratio8- 0.93 Beta + 7.61 D_Country risk , R

2=5.7%

PER = 17.3 + 4.3 Payout ratio 0.717 Beta + 7.24 D_Country risk 5.04D2-

2.08D3- 2.69D4 + 0.07D5 - 3.35D6- 2.1D7, R2= 6.6%

P/S = 0.43+ 0.074Marja Operaional + 0.044NI/Sales -0.38Beta+ 1.02

D_Country risk, R2=46.3%

P/S = 0.51 + 0.07Marja Operaional+ 0.044NI/Sales 0.33Beta 0.295D2 -

0.72D3 - 0.21D4 - 0.20D5 - 0.69D6 -0.54D7 + 0.9 D_Country risk, R2=47%

P/B = 1.19 - 0.12Beta - 0.0001Payout + 0.0001ROE + 1.81 D_Country risk -

0.12D2 + 0.54D3 - 1.44D4 + 0.21D5 - 0.34D6 + 0.34D7, R2=7.5%

P/B = 0.79 + 1.77 D_Country risk

The results obtained sustain the necessity of adjusting multiples taken from a

developed country both for country risk and for industry difference.

In this paper we have used several research methods: econometric analysis,

synthesis, comparison and study case. We have also considered it necessary to have a

number of 16 annexes that complete and justify the results found in our paper. We

consider that this topic is a complex and up-to-date one.

7Pereiro, Luis, Valuing Companies in Emerging Markets, Editura Wiley Finance, New York, 20028Written as 0.0X


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Relative valuation can be done with fewer initial hypotisys and faster that through

any other valuation method; it is simpler to understand and easier to show to clients than

other valuation techniques; its more probable to reflect the markets current state

because its an attempt of measuring a relative value and not an intrinsic one. Moreover,

multiples derive from spot prices which reflect several inverstors expectations and not

only ones.

Market multiples ratio leads us to adjusments of 57% (for PER), 31.7% (for P/B)

and 32% (for P/S). At this stage we introduced sector difference and we computed

adjusments for the three multiples based on industry belonging. This corrections were

calculated as stated before (medians ratio).

Finally, we ran a series of regressions in which we introduced dummy variables to

quantify country and industry risk. The results were obvious, the necessity of adjusting

multiples was sustained by the validity of the econometric models. Based on the data as

at april 2012, we can state that for PER, the multiple should be adjusted, if taken from the

U.S with approximately 50.8%. For Romania it should be 14.92 and for the U.S 22.4.

We consider that the paper can be used as a framework in determining the

necessary adjusments of multiples taken from a developed economy. Moreover, the

synthetic ecuations for P/S and P/B can be used in practice to compute these multiples.

We must keep in mind that these ecuation are valid at a certain time, and as data change

in market, these equation will suffer changes as well.

This paper can also be used by multinational companies that have branches

located within an emergent market. Because of globalization, more and more companies

are turning towards emerging markets and thus, valuation in a comparable poor

environment becomes something of the present.

At a first glance, using multiples might seem an easy and direct method.

Unfortunately, in practice, it is not as easy at is seems. Selecting multiples to truly reflect

value and identifying a comparable group implies some problems.


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BIBLIOGRAPHY

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3. Anghel, Ion; Stan, Sorin V.;Evaluarea ntreprinderii, Editura ASE, Bucureti, 20034. Benninga, Simon Z., Oded H. Sarig, Corporate Finance: A valuation Approach,

McGraw- Hill, New York, 1997

5. Boatsman, James R./Baskin, Elba F., Asset valuation with incomplete markets, in: TheAccounting Review, Vol. 56, No. 1, 1981

6. Ciobanu Anamaria, Dumitrescu Dalina, Dragot Victor, Evaluarea ntreprinderilor,Editura Economic, Bucureti, 2002

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11.Dittmann Ingolf, Weiner Christian, Selecting Comparables for the valuation of EuropeanFirms, Humboldt University, Berlin, 2005

12.Fernandez, Pablo; Bilan,Andrada, 110 Common errors in company valuations, REPEC,Madrid, 2007

13.Fernandez, Pablo Valuation Using Multiples. How do analysts reach theirconclusions?, University of Navarra, Barcelona, 2002

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16.Lie E., Lie H. J, Multiples Used to Estimate Corporate Value, Financial Analysts Journal,Vol. 58, Numrul 2, (44-54), 2002


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17.Liu, Jing; Nissim, Doron; Thomas, Jacob, Equity valuation using multiples, Journal ofAccounting Research, Vol. 40

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19.Pecican, Eugen,Econometrie, Editura C.H. Beck, Bucureti, 200720.Pereiro, Luis, Valuing Companies in Emerging Markets, Editura Wiley Finance, New

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chiriac bogdan business valuation using multiples

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