The value of an enterprise is often based on (or supported by) multiples. Several multiples can be found in valuation practices. For instance, the equity value of a firm in the service industries is set equal to 1* turnover.
For enterprises, supplying tangible products, 5 * net income, 4* EBIT (earnings before interest and taxes) or 3* EBITDA (earnings before interest taxes depreciation and amortization) are more common.
Note that the above mentioned multiples are generic and by far not industry specific. As if all industries would financially perform identical. As if firms in these industries are equally attractive to buyers! Which are of course minus one thoughts!
So, valuation by using multiples is moreover a quick and dirty method. This approach is acceptable as far as the outcome will not be given too much of a weight. As supportive to other firm valuation techniques.
When we apply the above mentioned multiples for the valuation of BriWiFra in our WACC article, we end up with the following valuation outcomes:
Equity value based on multiples | |
5 * Net income | 1846 |
4 * EBIT | 2120 |
3 * EBITDA | 2040 |
Although we should not give this too much of a weight, the outcomes appear to be pretty close to the WACC valuation outcome, i.e. 1965. So, this multiples valuation approach seems to give us at least a quick and general reference. But again, it does not take specific enterprise of industry characteristics into account! So, the valuation outcomes are therefore extremely vulnerable to disputes about the correctness.
Note that the concept of multiples in this article applies to Small and Mediumsized Enterprises (SMEs).
Context of multiples
Multiples are -in one way or another- based on historic data and market expectations: at what prices are stock in SME enterprises traded. So, multiples are an indication of the market value of equity. This needs a bit of elaboration!
Market value of an object is the estimated amount at which that object would be transferred on a predetermined valuation date, while
- both buyer and seller (parties) are willing to do such a transaction,
- parties have acted with discretion and not under stress (or pressure) and
- the transaction is a result of an appropriate process of preparation and marketing.
The market value is -more or less- the equilibrium between supply and demand. The market value is highly predictable if the market is efficient. This occurs when market players, i.e. supplying and demanding actors, meet due to plentiful information and transactions are at predictable and low cost.
So, if one would like to know the value of a used car (specific type, age, engine, mileage, et cetera), a specific type of hairdryer, airline tickets, et cetera, one could easily check the internet and quickly find prices. Or at least: find some price ranges. Here, supply and demand are easily and quickly matched. Pricing is transparent. Transactions are cheap.
Applying the concept of market value to valuation of SME enterprises raises the question: is there a market for enterprises. And the answer should be: “Yes, of course!” Otherwise, there would not be any business sales of succession what so ever, quod non. But for businesses, the market is –unfortunately- highly inefficient. Information is incomplete or inadequate. Transactions costs are high and less predictable. Buyers and sellers need active support to be matched and to come to a transaction.
Comparables
This brings us to the concept of comparables. The valuation outcome is the result of comparing the attributes of an object to those of which we have an easy access to more specific price information. If the market is willing to pay X for Y, then another Y will probably cost X as well. The concept of comparables however is less appropriate for SME businesses. Because firms in the same market with the same products or services never perform identical. They will always generate different cash flows due to different market positions, investment cycles, assets and business management performance, portfolio perspectives, et cetera. The diversity of attributes is too large and too complex to make this concept of comparables work.
Specific multiples
So, is there nothing to do? This brings us at our last resort (and also our starting point): multiples. And here, we can do some improvements by looking for more industry specific multiples. As an example, we learned from market research that enterprises in the building construction industry have an average EBITDA (earnings before interest taxes and depreciation and amortization) of 4.5% (of total turnover). Sales prices of equity of these firms are at 3.8 x EBITDA.
So, what does this mean for BriWiFra? Based on this, the equity value of BriWiFra, based on market data, would be 4.5% * 3.8 * 6000 = 1026. And this is unfortunately a bit less than based on the WACC method valuation outcome of 1965. This is also a bit less than the book value of equity of BriWiFra, i.e. 1160.
One could also argue that BriWiFras’ EBITDA is 630, which is 10.5% of its turnover. This would give a equity value outcome of 2394.
So, with help of multiples we came to a quick valuation outcome. However, the valuation outcomes differ considerably, which is a source for many disputes and disagreements. Correctness is therefore highly questionable.