What is Precedent Transaction Analysis?
Precedent Transaction Analysis estimates the implied value of a company by analyzing the recent acquisition prices paid in comparable transactions.
Precedent Transaction Analysis: Training Tutorial
The premise of precedent transaction analysis – often used interchangeably with the term “transaction comps” – is that similar transactions of comparable companies can serve as a useful point of reference when valuing companies.
In short, precedent transaction analysis utilizes multiples to calculate the value of a target.
Thus, precedent transaction analysis is a method of valuing a company based on the purchase multiples recently paid to acquire comparable companies.
Once the peer group of comparable transactions and the appropriate valuation multiples are selected, either the median or mean multiple of the peer group is applied to the target’s corresponding metric to arrive at a transaction comps-derived value.
The estimated valuation from transaction comps is not meant to be a precise calculation, but rather establishes valuation parameters for the target company based on what other buyers paid for similar companies.
From the perspective of a buyer and seller, as well as their advisors, the goal is to gain insight on:
- Buy Side → “How much should we offer to purchase the company?”
- Sell Side → “How much can we sell our company for?”
Based on the circumstances surrounding each transaction, a higher premium (or discount) could be warranted, but the acquirer can benchmark against comparable transactions to ensure their offer price is “reasonable” and most importantly, as a sanity check.
Valuation Multiples Review: Enterprise Value vs. Equity Value
Just to briefly review, a valuation multiple is comprised of a value measure in the numerator – i.e. enterprise value or equity value – whereas the denominator will be an operating metric like EBITDA or EBIT.
It is important to ensure that the represented investor groups (i.e. the capital providers) must match both the numerator and denominator.
- Enterprise Value Multiple: TEV multiples are more practical due to being capital structure neutral, i.e. the enterprise value represents all the providers of capital, such as debt and equity holders.
- Equity Value Multiple: On the other hand, equity value multiples represent the residual value remaining just for common shareholders – for example, the P/E ratio.
Comparable Transactions Screening Criteria
The “peer group” in transaction comps analysis describes the collection of recent M&A transactions involving companies with characteristics that are similar to that of the target.
When selecting which types of companies sufficiently meet the criteria to be placed in the peer group, considerations include:
- Business Characteristics: Product/Service Mix, Key End Markets Served, Customer Type (B2B, B2C)
- Financial Profile: Revenue Growth, Profit Margins (Operating and EBITDA Margins)
- Risks: Regulatory Landscape, Competitive Landscape, Industry Headwinds or Tailwinds, External Threats
However, “pure-play” transactions are virtually non-existent, so flexibility must be retained in the screening process, especially for niche industries.
Particularly for precedent transaction analysis, it is important that the transactions occurred relatively recently because dissimilar macroeconomic conditions can create significant differences in valuations.
The necessary data to perform transaction comps can be acquired from the following sources:
- Deal Announcement Press Releases
- Merger Proxy and 8-Ks
- Tender Office Documents (Schedule 14D-9, Schedule TO)
- Financial Reports (10-K / 10-Q Filings)
- Management Presentations
- Equity Research Reports (M&A Commentary)
Precedent Transaction Analysis Guide (Steps-by-Step)
|Step 1. Compile Comparable Transactions||
|Step 2. Market Research||
|Step 3. Input Financial Data||
|Step 4. Calculate Peer Group Multiples||
|Step 5. Apply Multiples to Target||
Transaction Comps Peer Group: Deal Considerations
When putting together a peer group for transaction comps, the following are examples of diligence questions to keep in mind:
- Transaction Rationale: What was the transaction rationale from both the buyer’s and seller’s perspectives?
- Overpaying is a common occurrence in M&A, so the outcome of the deal should be assessed.
- Buyer Profile: Was the acquirer a strategic or a financial buyer?
- Strategic acquirers can afford to pay a greater control premium than financial buyers because strategics can benefit can synergies.
- Sale Process Dynamics: How competitive was the sale process?
- The more competitive the sale process, i.e. the more buyers that are serious about acquiring the target, the greater the likelihood of a higher premium.
- Auction vs. Negotiated Sale: Was the transaction an auction process or negotiated sale?
- In most cases, a sale structured as an auction will result in a higher purchase price.
- M&A Market Conditions: What were the market conditions at the time when the deal closed?
- If the credit markets are healthy (i.e. if access to debt to partially fund the deal or share price is relatively easy), then the buyer is more likely to pay a higher price.
- Transaction Nature: Was the transaction hostile or friendly?
- A hostile takeover tends to increase the purchase price, as either side does not want to be on the losing end.
- Purchase Consideration: What was the purchase consideration (e.g. all-cash, all-stock, mixture)?
- A transaction in which the purchase consideration was stock rather than cash is more likely to be valued less than an all-cash transaction since the shareholder can benefit from the potential upside post-deal.
- Industry Trends: If the industry is cyclical (or seasonal), did the transaction close at a high or low point in the cycle?
- If the transaction occurred at an unusual time (e.g. cyclical peak or bottom, seasonal swings), there can be a material impact on pricing.
Transaction Comps: Pros and Cons
Control Premium in M&A (%)
Transaction comps analysis typically yields the highest valuation because it looks at valuations for companies that were acquired – meaning that a control premium is included in the offer price.
A control premium is defined as the amount that an acquirer paid over the unaffected market trading share price of the company being acquired, typically expressed as a percentage.
As a practical matter, a control premium is necessary to incentivize existing shareholders to sell their shares and forego their ownership.
Control premiums, or “purchase premiums,” are paid in the vast majority of M&A deals and can be quite significant, i.e. can be as high as 25% to 50%+ above unaffected market prices.
In the absence of a reasonable control premium, it is unlikely that an acquirer will be able to obtain a controlling stake in the acquisition target, i.e. the existing shareholders typically need an extra incentive that compels them to give up their ownership.
Hence, the multiples derived from transaction comps (and the implied valuations) tend to be the highest when compared to the valuations derived from trading comps or standalone DCF valuations.
A key benefit to transaction comps is that the analysis can provide insights into historical control premiums, which can be valuable points of reference when negotiating the purchase price.