Solving Valuation Problems in a Depressed Market
2:46 PM MDT | June 5, 2009 | By CHRIS CERIMELE
One of the most common questions that I get asked by clients is how best to value a business when many of the traditional valuation methodologies seem inadequate in the current market. While there is no one definitive answer, I have found that there are still ways to arrive at numbers that will work for both buyer and seller.
Two of the methodologies that we have tended to de-emphasize lately are public comparables and transaction comparables. Both are difficult measures of value right now, for different reasons.
Public comparable analysis is the practice of gauging valuation of a business based on the public market valuation statistics of a set of public companies that most closely resembles the target business to be valued. This method has always been imperfect because no two companies are perfectly alike. However, in the last 12-18 months public market values have declined as much as 50%. Specialty chemical companies that were trading at an average over 8.0x to 8.5x EBITDA over the prior ten years are now trading at half that value. What does this mean? Are these companies really worth sharply lower multiples or is the market overreacting to recessionary fears? The uncertainty makes us reluctant to rely too heavily on this methodology.
Transaction comparables pose another issue, which is that overall transaction volume has declined sharply in the last 12 months even for mid-sized and smaller deals. Many of the deals that do get completed involved distressed situations. So we often have the problem that the best available data relates to older transactions. Is it fair to base a valuation on transactions that were completed in the past under very different market conditions?
With public company and transaction comparables less reliable in the current market, we tend to place more emphasis on fundamental valuation. That is, evaluating a company on its own merits. This involves analyzing its current financial performance and financial position, as well as its future prospects and cash flow forecast. A discounted cash flow analysis often plays a prominent role in such analysis, but need not be relied upon exclusively. Some form of benchmarking vs competitors as well as an overall qualitative analysis can also help with the assessment. In some cases a liquidation scenario will also provide a useful data point.
Valuation is as much art as it is science, and the current market provides its own set of unique challenges. With the proper tools and analytical framework, and often a little creativity, one can almost always find a solution.