PYA Consultant Will Hamilton was a featured speaker at NACVA, Georgia Chapter. His presentation, “Market Approach: Adjusting Valuation Multiples,” outlined methods for adjusting guideline valuation multiples for size, growth, and company-specific risk.

1. Market Approach:
Adjusting Valuation Multiples
October 25, 2013
William B. Hamilton, MBA, CVA
NACVA Georgia State Chapter Meeting
October 25, 2013
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2. Agenda
Introduction
Adjusting for Size
Adjusting for Growth and CSR
Conclusion
Market Approach Resources
NACVA Georgia State Chapter Meeting
October 25, 2013
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3. Introduction
The income approach is the market approach,
the market approach is the income approach.
A multiple of 5X is a capitalization rate of 20%,
a capitalization rate of 20% is a multiple of 5X.
“Finkel is Einhorn, Einhorn is Finkel.”
- Ace Ventura
NACVA Georgia State Chapter Meeting
October 25, 2013
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4. Introduction
Cap rate
Inverse of valuation multiple
5X EBITDA = “an EBITDA capitalization rate of 20%”
NACVA Georgia State Chapter Meeting
October 25, 2013
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5. Introduction
PGC multiple =
Convert to cap rate =
Add size adjustment1 =
Add growth adjustment2 =
Subject company cap rate =
Convert to multiple =
1
2
8X
12.5%
5.0%
2.5%
20.0%
5X
Subject size premium less PGC size premium.
PGC growth rate less subject growth rate.
NACVA Georgia State Chapter Meeting
October 25, 2013
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6. Adjusting for Size
NACVA Georgia State Chapter Meeting
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7. Adjusting for Size
• SBBI Deciles
• Duff & Phelps Portfolios
• Duff & Phelps Regression Formulas
NACVA Georgia State Chapter Meeting
October 25, 2013
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8. Adjusting for Size
NACVA Georgia State Chapter Meeting
October 25, 2013
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9. Adjusting for Size
NACVA Georgia State Chapter Meeting
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10. Adjusting for Size
Which Exhibits to use?
• D&P “A&B Exhibits” apply to equity
• D&P “C Exhibits” apply to invested capital
Most applications are “capital structure” neutral, i.e. MVIC to EBITDA
NACVA Georgia State Chapter Meeting
October 25, 2013
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11. Adjusting for Size
HURN
Size Adjustment
Total revenues
Constant
Slope
Size-adjusted ERP based on revenues
Size Adjustment, Rounded
$
FCN
CRAI
677,100,000
0.15060
(0.02097)
9.12%
$ 1,610,000,000
0.15060
(0.02097)
8.34%
3.80%
4.60%
$
NCI
261,780,000
0.15060
(0.02097)
9.99%
3.00%
$
Subject
752,440,000
0.15060
(0.02097)
9.03%
$
10,000,000
0.15060
(0.02097)
12.96%
3.90%
NACVA Georgia State Chapter Meeting
October 25, 2013
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12. Adjusting for Growth or CSR
NACVA Georgia State Chapter Meeting
October 25, 2013
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13. Adjusting for Growth
Optional adjustment. Some considerations:
• Can use DCF to compute 5-yr CAGR for Subject
• Blend with long-term growth rate
• Analyst 5-yr growth estimates available for many PGCs
• Blend with long-term growth rate (estimate)
NACVA Georgia State Chapter Meeting
October 25, 2013
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14. Adjusting for Growth
HURN
Growth Adjustment
Growth estimate (5 years)
Long-term growth estimate
FCN
CRAI
NCI
Subject
14.37%
5.00%
13.50%
5.00%
12.00%
5.00%
11.67%
5.00%
6.50%
3.00%
Blended growth rate
6.99%
6.64%
6.74%
6.48%
4.42%
Growth Adjustment
2.60%
2.20%
2.30%
2.10%
NACVA Georgia State Chapter Meeting
October 25, 2013
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15. Adjusting for CSR
Optional qualitative adjustment. Some good reasons include:
• Extreme customer concentration
• Aging equipment relative to industry
• Unfavorable local demographics
• Poor business mix
• Significantly lower margins
NACVA Georgia State Chapter Meeting
October 25, 2013
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16. Putting it All Together
NACVA Georgia State Chapter Meeting
October 25, 2013
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17. Conclusion
HURN
Share price
Shares outstanding
$
Estimated market value of equity
Interest bearing debt
FCN
58.13
22,350,000
NCI
40.26
39,140,000
$
18.43
10,180,000
$ 1,299,205,500
$
181,890,000
$ 1,575,776,400
$
723,000,000
$
$
187,617,400
6,840,000
$ 848,320,800
128,420,000
Market value of invested capital (MVIC)
$ 1,481,095,500
$ 2,298,776,400
$
194,457,400
$ 976,740,800
EBITDA
$
$
$
22,930,000
$ 122,830,000
144,880,000
Unadjusted MVIC to EBITDA multiple
$
CRAI
254,340,000
$
16.98
49,960,000
10.22
7.95
11.06%
4.60%
2.20%
2.00%
19.86%
11.79%
3.00%
2.30%
2.00%
19.09%
12.58%
3.90%
2.10%
2.00%
20.58%
5.50
Adjusted MVIC to EBITDA multiple
8.48
9.78%
3.80%
2.60%
2.00%
18.18%
EBITDA capitalization rate
Add: Size adjustment
Add: Growth adjustment
Add: Company-specific adjustment
Adjusted EBITDA capitalization rate
9.04
5.03
5.24
4.86
Subject base year EBITDA $
Average adjusted EBITDA multiple
1,000,000
5.16
Indicated value of invested capital $
5,160,000
Rounded
$
5,160,000
NACVA Georgia State Chapter Meeting
October 25, 2013
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18. Conclusion
Two methods of
estimating the
cost of capital;
The only
difference is the
foundation.
Income Approach
• Uses returns of
entire stock market
as foundation
• Adjust for size
• Adjust for growth
• Adjust for qualitative
risk factors
Market Approach
(
• Uses industry cap
rates set by market
as foundation
• Adjust for size
• Adjust for growth
• Adjust for qualitative
risk factors
NACVA Georgia State Chapter Meeting
October 25, 2013
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19. Conclusion
There are practical differences between Income & Market Approaches:
1. The equity risk premium is calculated based on a different set of
empirical data
2. Results can be skewed due to uneven growth rates
3. Market multiples are usually expressed in terms of EBITDA, which is
used as a proxy for free cash flow
4. Capex/WC needs as a % of EBITDA should be monitored
5. Getting to “clean” EBITDA figure for PGCs can be tricky
6. Some PGC’s may have advantageous tax situations, increasing
EBITDA to FCF conversion
NACVA Georgia State Chapter Meeting
October 25, 2013
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20. Market Approach Resources
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21. Market Approach Resources
PGC Method
• Capital IQ
• FetchXL and iMetrix
• PitchBook
• Yahoo! Finance, MarketWatch, Finviz, GuruFocus
• Others?
M&A Method
• Pratt’s Stats
• BizComps
• IBA Database
• Pitchbook
• Industry Specific: Irving Levin, Moss Adams, etc.
• Others?
NACVA Georgia State Chapter Meeting
October 25, 2013
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22. Contact Information
William B. Hamilton, MBA, CVA
Consulting Manager
(404) 266-9876
whamilton@pyagatesmoore.com
NACVA Georgia State Chapter Meeting
October 25, 2013
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