Valuation Comparables

Ideko Financial Statements

After initial conversations with the founder, you have obtained estimates of Ideko’s income statement and balance sheet for the current fiscal year, shown below here:

Valuation Comparables

To obtain your first estimate of the company, you decide to value the firm by looking at comparable companies. At a price of $150 million, Ideko’s P/E ratio is 21.6, roughly equal to the market average P/E ratio in mid-20X5 (see below).

It can be quite informative to compare Ideko to firms in the same line of business. Although no firm is exactly comparable to Ideko in terms of overall product line, three firms with which it has similarities are Oakley Inc., Luxottica Group, and Nike Inc.

The closest competitor is Oakley which also designs and manufactures sports eyewear. Luxottica Group is an Italian eyewear maker, but much of its business is in prescription eyewear; it also owns and operates a number of retail eyewear chains. Nike is a manufacturer of speciality sportswear products, but its primary focus is footwear.

You decide to compare Ideko to a portfolio of firms in the sporting goods industry. Your findings are summarised below:

The table not only shows the P/E ratio, but also each firm’s enterprise value (EV) as a multiple of sales and multiple of EBITDA.

Enterprise Value is the total value of equity plus net debt, where net debt is debt less cash and investments in marketable securities that are not required as part of normal operations. Ideko has $4.5 million in debt. You also estimate that it holds $6.5 million of cash in excess of its working capital needs. Therefore, Ideko’s enterprise value at the proposed acquisition price is 150 + 4.5 – 6.5 = $148 million.

P/E & EV/Sales ratios

At the proposed price, Ideko’s P/E ratio is low relative to those of Oakley and Luxottica, although it is somewhat above the P/E ratios of Nike and the Industry overall.

The same can be said for Ideko’s valuation as a multiple of sales. Based on these two measures, Ideko looks “cheap” relative to Oakley and Luxottica, but it is priced at a premium relative to Nike and the average sporting goods firm.

EV/EBITDA ratio

The deal however stands out when you compare Ideko’s Enterprise Value relative to EBITDA. The acquisition price of just over nine times EBITDA is below that of all comparable firms as well as the industry average. Ideko’s low EBITDA is a result of its high profit margins. At 16,250 / 75,000 = 21.7%, its EBITDA margin exceeds that of all comparables.

Multiple Variation

As with any comparison, the multiples vary quite substantially. For example – looking at the second table above, Nike has the lowest P/E multiple of 18.2. Multiplying this P/E by Ideko’s earnings of $6.94 million gives a value of 18.2 * 6.94 = $126.3 million. The highest multiple of enterprise value to sales is 2.7 (Luxottica); at this multiple, Ideko’s enterprise value is 2.7 * 75 = $202.5 million. Adding Ideko’s excess cash and subtracting its debt implies a purchase price of 202.5 + 6.5 - 4.5 = $204.5 million.

Both tables above demonstrate that while comparables provide a useful benchmark, they cannot be relied upon for a precise estimate of value. Furthermore, they ignore important differences such as operating efficiency and growth prospects of the firm. They also do not reflect the Kleiner Perkins’ plans to improve Ideko’s operations.

To assess whether the investment is attractive requires a careful analysis both of the operational aspects of the firm and ultimate cash flows the deal is expected to generate and return that should be required.

This is what we do in the following sections.