Takeover Price
EPS
Sales per Share
P/E
P/S
AAA
65
4.80
48.00
13.5
1.35
BBB
149
10.40
118.75
14.3
1.25
CCC
26
1.80
19.50
14.4
1.33
An analyst has identified three companies that have recently been taken over which they believe are comparable to a firm under evaluation as a takeover candidate. The relative value measures that they have selected are the price-to-earnings (P/E) and price-to-cash flow (P/CF), and the average values of these ratios are 11.2 and 8.6. The target firm has earnings per share of $2.45, and cash flow per share of $3.05. What is the estimated takeover price per share?
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The estimated value based upon P/E is $27.44 = (2.45 × 11.2).
The estimated value based upon P/CF is $26.23 = (3.05 × 8.6).
The estimated takeover price is the average of these two values: $26.84.
The quick change oil industry has been in a consolidation phase for about a decade, during which time the number of firms has shrunk from more than 50 to 15. An analyst is evaluating one of the remaining 15 firms as an acquisition target, and has come up with the following estimated acquisition prices:
Under the circumstances, which of these estimates is most likely to represent the ultimate acquisition cost, and why?
Methods of Analysis
Price per Share
Discounted CF
$50
Comparable Company
$48
Comparable Transaction
$57
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Given the large number of acquisitions that have occurred in the industry, comparable transaction is likely to provide the most reliable estimate of the ultimate acquisition price. Comparable company analysis is certainly a viable method to estimate value, but still requires the analyst to estimate the takeover premium. This step is unnecessary when using the comparable transaction approach. Discounted CF valuation is also a viable method, but, in the presence of numerous comparable firms and transactions, logic suggests that the market-based valuation provided by the comparable transaction approach is more likely to produce superior results.
An analyst has identified three companies (AAA, BBB, and CCC) that have recently been taken over and are comparable to a firm under evaluation as a takeover candidate. The relative value measures they have selected are the price-to-earnings (P/E) and price-to-sales (P/S). The takeover price, earnings per share, and sales per share, for each company, respectively, are as follows:
| Takeover Price | EPS | Sales per Share | |
| AAA | 65 | 4.80 | 48.00 |
| BBB | 149 | 10.40 | 118.75 |
| CCC | 26 | 1.80 | 19.50 |
What values for these ratios should be applied to the target firm?
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Takeover Price
EPS
Sales per Share
P/E
P/S
AAA
65
4.80
48.00
13.5
1.35
BBB
149
10.40
118.75
14.3
1.25
CCC
26
1.80
19.50
14.4
1.33
Which of the following orderings is the most accurate with regard to the steps involved in valuation using comparable transaction analysis?
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The correct ordering is: identify recent takeovers of comparable companies, calculate relative value measures, apply relative value measures to target firm. Identifying comparable companies is not correct by itself because they need to have been taken over. There is no need to estimate the takeover premium because this will be present in the relative value measures for firms that have been taken over.
Clothing Tree is a Milan-based holding company. The holding company comprises individual firms with unique brands that produce and sell products ranging from infant and children’s clothing, to fashion wear, to work uniforms, to undergarments. The firm’s founder and chairman, Romano Nocci, says that “since we assume that people will continue to wear clothes, we continue to believe that this is a good business for the long haul.”
However, in spite of his overall belief in the soundness of the clothing market, he realizes that tastes and fashions change, and believes that the firm should constantly be on the lookout for suitable candidates to add to the Clothing Tree empire. He also believes that it may make sense to restructure the firm by creating a new holding company, Family Tree, to own the Clothing Tree plus two new divisions—Food Tree and Drug Tree.
The Food Tree would be a holding company formed to acquire companies in all phases of the food business. The Drug Tree would be a holding company formed to acquire companies in all phases of the non-prescription pharmaceuticals market. Both of these product lines are necessary goods, so Nocci believes that they would fit well with the firm’s existing clothing businesses.
To help implement this acquisition strategy, Nocci has hired Zurich Investment Advisers. Armando Palocci, CFA has been assigned to be the lead advisor in this effort. When Palocci and his team met with Nocci and other key Tree managers, they discussed a wide-ranging set of subjects relating to the nascent acquisition plans. These discussions are summarized in the paragraphs below.
Palocci asks whether additions to the Tree empire will continue to maintain their identities. For example, if Food Tree were to purchase Parma Foods, would the company be operated as a subsidiary and maintain its identity, or would it be combined with other acquisitions and rebranded as Food Tree? Nocci indicates that this would likely depend upon the value of maintaining the brand versus the efficiencies that could be gained from combining acquisitions.
Does the Tree want to avoid firms that have takeover defenses in place? If so, which types of defenses? Nocci responds that he “would prefer to avoid firms that have pre-offer defenses, such as poison pills and pac-man defenses in place because these make the cost of an acquisition prohibitive. However, if a firm has shown a willingness to pay greenmail in the past, he would not be averse to testing the management again on this count.”
Some of the acquisition targets will likely have business interests in the U.S. and Canada, as well as Europe. Palocci describes to Nocci how industry concentration is measured in the U.S., and what might cause an acquisition to be challenged on antitrust grounds. Nocci indicates that whether or not it makes sense to run the risk of an antitrust challenge will depend, in part, on the potential gains from the merger. Thus, they must be evaluated on a case by case basis.Palocci and Nocci conclude their discussions with a review of acquisition target valuation methods, the evidence concerning the distribution of merger benefits, and strategies that the firm might employ if it were to purchase a firm with several divisions, some of which it does not wish to keep.
If Food Tree is successful in purchasing a food company for which it maintains the firm’s existing identity and brands, the first such purchase would be classified as a:
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The first food company, being in an entirely different business from clothing, would have to be considered a conglomerate merger. The fact that the firm intends to maintain the target’s identity after it is acquired indicates that it would be considered a subsidiary merger. (Study Session 9, LOS 33.a)
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Nocci is correct with respect to the poison pill defense. It is a pre-offer defense that can make an acquisition prohibitively expensive. The pac-man defense is a post-offer defense. It involves the acquisition target turning the table and attempting to acquire the firm that is making the offer. (Study Session 9, LOS 33.f)
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Palocci should have told him that the decision to challenge is based upon a quantitative measure of industry concentration, but that the issue is not necessarily clear-cut. (Study Session 9, LOS 33.h)
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If a firm is in financial distress or experiencing earnings problems, this will make it difficult to apply the comparable company or comparable transaction approaches. However, if the firm can be restored to health and future cash flows and risks are fairly predictable, this implies that discounted cash flow valuation may provide the best results. (Study Session 9, LOS 33.j)
Fuel Cell Enterprises is in a new and rapidly-evolving industry, and is being evaluated as an acquisition candidate by Auto Giant, Inc. There are about 10 firms that broadly resemble Fuel Cell, but none of its competitors have been taken over up to this point. Because of the nature of the firm’s technology, the level of risk is difficult to estimate and may change rapidly as the technology matures. Which type of analysis is likely to be most appropriate in the valuation of Fuel Cell?
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The fact that no mergers of similar companies have occurred effectively rules out comparable transaction analysis. The difficulty in estimating the firm risk suggests that discounted cash flow analysis is fraught—small changes in the discount rate can lead to large changes in estimated firm value. Since there is a sufficiently large sample of firms similar to Fuel Cell, this suggests that comparable company analysis is likely to be most appropriate.
Which of the following orderings is most accurate with regard to the steps involved in valuation using comparable company analysis?
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The correct ordering is identify comparable companies, calculate relative value measures, apply value measures to target firm, estimate takeover premium, and calculate the estimated takeover price. Note that the estimation of the takeover premium could be done at any point prior to the final step, but the other four steps are sequential.
An analyst has identified three companies that they believe are comparable to a firm under evaluation as a takeover candidate. The relative value measures they have selected are price-to-earnings (P/E) and price-to-cash flow (P/CF). The market price, earnings per share, and cash flow per share, for each company, respectively, are: $55, 4.80, 6.26; $129, 10.40, 13.75; and $19, 1.80, 2.10. What values for these ratios should be applied to the target firm?
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An analyst has identified three companies that they believe are comparable to a firm under evaluation as a takeover candidate. The relative value measures that they have selected are price-to-earnings (P/E) and price-to-sales (P/S), and the average values of these ratios are 13.2 and 1.3. The target firm has earnings per share of $3.75, and sales per share of $36.08. If the estimated takeover premium is 25%, what is the estimated takeover price per share?
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The estimated value based upon P/E is $49.50 = (3.75 × 13.2).
The estimated value based upon P/S is $46.90 = (36.08 × 1.3).
The average of these two values is $48.20.
The estimated takeover price is $48.20 × 1.25 = $60.25.
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