Valuing a company is one of the key tasks of an investment banker. One common valuation methodology that investment bankers use is Precedent Transactions Analysis (PTA). In this article, we will explain what PTA is, how it works, and the steps involved in this type of valuation methodology.
What is Precedent Transactions Analysis?
Precedent Transactions Analysis is a relative valuation methodology used to value a company by comparing it to similar companies that have been acquired in an M&A transaction. This method assumes that the value of a company is similar to what comparable companies have been bought out for in the past.
To illustrate this concept, consider the example of a house. If your house is very similar to your neighbors’ houses, and they have been sold for $500,000 each, it’s safe to assume that your house is also valued at around $500,000. The same concept applies to companies. If a company is similar to others that have been acquired, it’s likely that the company’s value is similar to what those other companies were bought out for.
Steps Involved in Precedent Transactions Analysis
There are five key steps involved in Precedent Transactions Analysis.
Step 1: Selecting Precedent Transaction Comps
To find similar transactions, it’s important to look at comparable companies in terms of size, geography, industry, and time. Time is a crucial factor because market dynamics change, and using transactions that occurred too far back may not provide an accurate reflection of the company’s value.
Equity research reports and databases such as Capital IQ, Mergerstat, and Thomson Reuters can help you find precedent transaction comps. Ideally, you should have between six to ten transactions to get a good idea of how to value the company.
Step 2 and 3: Spreading and Normalizing Precedent Transactions
The next step involves inputting financial data into an Excel template. This data includes pre-announcement and post-announcement share prices, figures from the income statement, balance sheet, cash flow statement, share count, and option count and details.
Obtaining this information can be difficult, especially for private companies that do not have to disclose financial information. However, if you’re dealing with public companies, this information is publicly available.
Step 4: Calculating Multiples
Once you have the financial data, the next step is to calculate the multiples. These include EV/EBITDA, EV/EBIT, price-to-book value, and other industry-specific multiples. To calculate the multiples, you’ll need to use the financial data inserted in step two and three.
You’ll also need to calculate the control premium, which is the extra amount paid when acquiring all the shareholders in a company. The control premium usually ranges from 20 to 40 percent, depending on the industry.
Step 5: Analysing Multiples
The final step in Precedent Transactions Analysis is to analyze the multiples. Look for anomalies and research why they are anomalies. If you have a good set of precedent transaction comps, you can find the mean or average and use that to apply to your company.
For example, if the average EV/EBITDA that you figured out from your set of precedent transactions is 8, you can multiply your EBITDA by 8 to figure out the enterprise value.
Limitations of Precedent Transactions Analysis
There are some limitations to Precedent Transactions Analysis that you should be aware of. One is market conditions. Transactions that occurred in the distant past may not accurately reflect current market dynamics. Additionally, obtaining financial data for private companies can be difficult.
Conclusion
In conclusion, Precedent Transactions Analysis is a popular valuation methodology used by investment bankers to value companies. It involves comparing a company to similar companies that have been acquired in the past to determine its value. The process involves selecting precedent transaction comps, spreading and normalizing the data, calculating multiples, and analyzing them. While this methodology has its benefits, such as providing a relative valuation and being easy to understand, it also has limitations, such as market conditions and the difficulty in obtaining financial data for private companies. Overall, Precedent Transactions Analysis is a useful tool in a banker’s arsenal for valuing companies, but it should be used in conjunction with other valuation methods for a more comprehensive analysis.
FAQs
Q: What is Precedent Transactions Analysis?
A: Precedent Transactions Analysis (PTA) is a valuation methodology used by investment bankers to determine the value of a company. PTA involves comparing a company to similar companies that have been acquired in the past to determine its value.
Q: How does Precedent Transactions Analysis work?
A: PTA works by assuming that the value of a company is similar to what comparable companies have been bought out for in the past. Investment bankers use this method to find similar transactions, input financial data into an Excel template, calculate multiples, and analyze them to determine the company’s value.
Q: What are the steps involved in Precedent Transactions Analysis?
A: There are five key steps involved in Precedent Transactions Analysis:
- Selecting Precedent Transaction Comps
- Spreading and Normalizing Precedent Transactions
- Calculating Multiples
- Analyzing Multiples
- Applying the Multiples to the Company Being Valued
Q: What are the limitations of Precedent Transactions Analysis?
A: One limitation of Precedent Transactions Analysis is that transactions that occurred in the distant past may not accurately reflect current market dynamics. Additionally, obtaining financial data for private companies can be difficult.
Q: What are the benefits of using Precedent Transactions Analysis?
A: Precedent Transactions Analysis provides a relative valuation, which is easy to understand. It is also a useful tool in a banker’s arsenal for valuing companies.
Q: Should Precedent Transactions Analysis be used in conjunction with other valuation methods?
A: Yes, Precedent Transactions Analysis should be used in conjunction with other valuation methods for a more comprehensive analysis.
Additional Resources
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