Multiples Approach to Horizon Value

Practitioners generally estimate a firm’s horizon value (also called the terminal value) at the end of the forecast horizon using a valuation multiple. While forecasting cash flows explicitly is useful in capturing those specific aspects of a company that distinguish it from its competitors in the short run, in the long run firms in the same industry typically have similar expected growth rates, profitability, and risk.

As a consequence, multiples are likely to be relatively homogeneous across firms. Thus, applying a multiple is potentially as reliable as estimating the value based on an explicit forecast of distant cash flows.

Horizon Value

Of the different valuation multiples available, the EBITDA multiple is most often used in practice. In most settings, the EBITDA multiple is more reliable than sales or earnings multiples because it accounts for the firm’s operating efficiency and is not affected by leverage differences between firms. We estimate the continuation value using an EBITDA multiple as follows:

From the income statement (Ideko - Forecast Earnings), Ideko’s EBITDA in 20Y0 is forecast to be $32.09 million. If we assume its EBITDA multiple in 20Y0 is unchanged from the value of 9.1 that we calculated at the time of the original purchase (Ideko - Valuation Comparables), then Ideko’s continuation value in 20Y0 is 32.09 * 9.1 = $292.05 million.

This calculation is shown in the spreadsheet below. Given Ideko’s outstanding debt of $120 million in 20Y0, this estimate corresponds to an equity value of $172.05 million.

Other Multiples

We can also see Ideko’s sales and P/E multiples based on this horizon value. The horizon value is 1.8 times Ideko’s 20Y0 sales, and the equity value is 16.3 times Ideko’s 20Y0 earnings.

Because the P/E multiple is affected by leverage, we also report Ideko’s unlevered P/E ratio, which is calculated as its horizon enterprise value divided by its unlevered net income in 20Y0. Ideko would have this P/E ratio if it had no debt in 20Y0, so this information is useful when comparing Ideko to unlevered firms in the industry.

We can use the various multiples to assess the reasonableness of our estimated continuation value. While the value-to-sales ratio is high compared to the overall sporting goods industry, these multiples are otherwise low relative to the comparables (Ideko - Valuation Comparables). If we expect these industry multiples to remain stable, this estimate of Ideko’s continuation value seems reasonable (if not relatively conservative).