Value Drivers in M&A Transactions The main objective of a buyer in an M&A transaction is to maximize the return on investment in the deal. The elements of a return include three major components: Price paid to the seller (the investment) Cash flow generated over the course of the investment Exit value – price received when the investment is sold The current value of a company in the M&A market is driven by the evaluation of buyers as to what price they need to pay to acquire the asset, what cash flows they feel they can generate over the course of the investment, and what value they feel they can realize when it's time to exit the investment. This evaluation is typically reduced to the EBITDA multiple -- cash flow times this multiple, less the company's debt, yields the equity value of the company. EBITDA multiples are similar in concept to the Price/Earnings ratios that are more common with stocks that trade in the public markets. Reducing a company's value to a simple metric such as an EBITDA multiple has a number of pitfalls yet serves as a useful proxy for making a comparison across industries and different companies. The question of what determines a company's EBITDA multiple is really a question of identifying those factors that determine the value of a potential acquisition. We have compiled a "top ten" list of the elements, or drivers, of a company's value in the M&A market. The valuation of any company can be highly complex; the following list is meant as a general guide for strategic planning as companies work towards building value, especially if an M&A transaction is contemplated in the future. The list is arranged in alphabetical order because these items are often weighted differently in importance depending on the investor or the industry: Barriers to Entry. A company is more valuable if it is difficult for competitors to enter the industry. These barriers may be due to the know-how that a company has built over its lifetime or to something as fundamental as personal relationships. Competitive Environment. If the industry is crowded with competitors undercutting each other on prices and margins, value is lower. On the other hand, a company with a unique geographic or product niche or a dominant market share is of greater value. "Financeability". Given the growing role of private equity groups in the market, the degree to which the company can be financially leveraged with debt has a significant impact on value. Private equity groups acquire companies primarily with debt sources, and a lesser amount of equity. The amount of debt they can raise for an acquisition sets a rough floor on valuations. Geography. Location has different aspects as it relates to value. There is location of marketplace – whether the company is tied to any one region that is attractive – or not. If sales are geographically diversified, then economic conditions in any one region will not have an adverse effect on earnings. If most of the operations are located in high cost areas of the country, this may be unfavorable as it relates to cost structure (although it might also be an opportunity for an acquirer with capacity in low cost areas). Growth Prospects. Growth drives multiples. Public companies with higher growth prospects have higher PE multiples. Private markets are the same. The higher the perception of growth opportunities, the greater the value. This relates back to investment returns; the better the prospects for increased cash flow over the course of the holding period, the greater the amount that can be paid to purchase the investment. Industry. Industries come in and out of favor, usually because of the perceptions of the market related to growth prospects. The value of a good company in a bad industry is often a tougher issue than a mediocre company in a hot industry. Perceptions are not static: a telcom company that was worth a fortune in 1999 couldn't be given away three years later. Metals companies that were on the verge of bankruptcy three years ago look like growth companies today. Timing is everything. Institutional Ownership. Industries that have institutional involvement, either public companies or private equity, are perceived as higher value situations. Smaller companies in industries that have larger institutional ownership often benefit from a "pack mentality." Investors like to follow the smart money. Management. Depth of management is critical as it relates to value. You can have the greatest, most profitable company in the industry, but if you don't have the depth required for continuity, value can be diminished sharply. Along with management a company should have the related systems, procedures, and processes to ensure that the business is not overly dependent on any one individual. Profitability. Profits are more than the one side of the equation that you apply the multiple against in order to determine value. Less volatility of earnings, higher growth, and good quality of earnings also push the multiples higher. In other words: profits - good, steady, and growing – are critical elements of value. Size. The bigger the company the higher the multiple. There is more money chasing the bigger deals. The determination of value is a complex process that, in the end, is determined by the marketplace regardless of whether the company is valued in a public market or in a private transaction. Each acquirer has a different process and unique method of assessing value. Despite different interpretations, these are the most commonly considered elements of value that a buyer will contemplate. James A. Lisy, CFA Managing Director Cohen Capital Advisors, Ltd.