TRADING COMPS

(target valuation using multiples from comparable companies)

1) Select the Universe of Comparables

Based on an in-depth study of the target’s sector and company characteristics. For
public companies the banker can rely upon annual and quarterly SEC filings (10-K
and 10-Q respectively), consensus research estimates1, equity and fixed income
research reports, press releases, earning call transcripts2, investor presentations and
corporate websites. For private companies, lacking of part of those documents, the
same sources referring to their public competitors can furnish useful insight on the
sector.

Key characteristics to be taken in considerations for comparison purposes: business

profile (sector, products and services, customers and end markets, distribution
channels, geography) and financial profile (size, profitability, growth profile, return
on investments, credit profile).

The research for competitors starts from a scratch that can be obtained from a
number of different sources such as 10-Ks, annual proxy statements3 (DEF14A),
investor presentations, equity research reports (especially if initiating coverages),
both of the company itself or of its public competitors. Additional sources: merger
proxies usually offer interesting prompts through the excerpts of the fairness opinion
(specifically, look for the list of comparables used for the trading comps performed as
to support the offer price); industry codes (e.g., SIC, NAICS); sector reports by
credit rating agencies.

2) Locate the Necessary Financials

In trading comps the valuation is driven by both historical (e.g., LTM) and
projected performance, depending on the target, the sector and the point of the
business cycle. In an M&A or debt capital raising transaction the most relevance is
reserved to LTM performance. The main information sources for each item are listed
in Appendix A.

N.B. From the 10-Ks and 10-Qs the MD&A section is of major importance for
projections and considerations on the past cycle. 10-Qs, in particular, can be valuable
to obtain the most recent data on the company and the sector. About 8-K, or current
report, it is filed by a public registrant to report the occurrence of material corporate

1
A consensus estimate is a forecast of a public company's projected earnings based on the combined estimates of all
equity analysts that cover the stock.
2
An earnings call is a teleconference, or webcast, in which a public company discusses the financial results of a
reporting period ("earnings guidance").
3
A proxy statement is a document containing the information the Securities and Exchange Commission (SEC) requires
companies to provide to shareholders so they can make informed decisions about matters that will be brought up at an
annual or special stockholder meeting.
events or changes (called “triggering events”) of importance for share- and
bondholders. For our purposes, main triggering events include earning
announcements, entry into a definitive purchase/sale agreement, completion of an
acquisiton or disposition of assets, capital market transactions and Regulation FD
disclosure requirements4.

3) Spread Key Statistics, Ratios and Trading Multiples

In this phase, a number of key financials must be collected and computated for each
parameter of the financial profile listed above.

Equity Value Equity Value=Share Price× Fully Diluted Shares Outstanding

FDSO=Basic Shares Outstanding+ In-the-Money Options∧Warrants+In-the-Money Convertible

Basic Shares Outstanding can be found in the first page of the target’s 10-K
or 10-Q (whichever reports the most recent data, eventhough the latest proxy
statement may still be more updated). ITM Options and Warrants, on the
other hand, can be computed employing the Treasury Stock Method5. To
compute ITM Converts the banker recurs to the If-Converted Method6 (with
the exception of the converts issued with the net share settlement accounting
feature7).

Enterprise Value
Enterprise Value=Equity Value+ Total Debt + Preferred Stock++ Noncontrolling Interest −Cash(¿ equivalents)

Size: Key Financial Data Sales, Gross Profit, EBITDA, EBIT, Net Income.

Profitability Gross profit margin, EBITDA and EBIT margin, Net income
margin.

4
Regulation FD (Fair Disclosure) provides that when a public filer discloses material nonpublic information to certain
personsit must make public disclosure of that information, typically through the filing of an 8-K.
5
TSM is based on the assumption that all the outstanding options and warrants can be excercised at their weighted
average strike price, while the proceeds from their execution is employed to repurchase part of the outstanding shares.
ITM options and warrants are those whose w. a. strike price is lower than the current share price. Thus, the repurchase
will reduce the number of additional shares, but still the number of FDSO will increase. Some bankers compute only
excercisable opt. and warr., but the most conservative method considers all ITM opt. and warr.
6
Given the conversion price, all the ITM converts are transformed in shares (the number can be obtained as
Amount Outstanding(¿ $)
Incremental Shares= ) and, since then, treated as equity (with the exception of
Conversion Price
GAAP reporting, where the most EPS dilutive method is employed: inclusion in the balance sheet and income statement
as debt or as equity) with the due consequences in terms of interest expense.
7
In this case, the issuer can recur to a partial cash settlement. In particular, the amount of new shares will only cover the
excess of the share price on the strike price, that is to say
Share Price−Strike Price Amount Outstanding(¿ $ )
Incremental Shares= × )
Share Price Conversion Price
Growth Profile The banker searchs for historical and projected growth rates of
selected financials (especially earnings8 and sales) as well as their
CAGRs.

Return on Return on Invested Capital9, ROE, ROA and Implied Dividend

Investments Yield10.

Credit Profile The credit profile is based on considerations regarding, for

instance, the ability of the enterprise to repay debt with its cash
flow generation and can be observed through a series of indicators.
Credit profile is assessed by credit rating agencies, which base
their analysis on leverage measures, such as Debt-to-EBITDA
and Debt-to-Total Capitalization, or coverage indicators, such as
the Interest Coverage Ratio11.

Read Appendix B for a detailed description of Calendarization of financials,

calculation of LTM Data and adjustements for Non-Recurring Items and Recent
Events.

Once the indicators and margins are calculated, key tranding multiples must be
spread for each company12. The main equity value multiple is the P/E ratio, that can
Share Price Market Equity Value
be computed as Diluted EPS or as Net Income
. It is mostly used for mature

companies and is typically based on projected EPS. It indicates how much the market
is willing to pay for each dollar of current and/or future earnings. It may be
problematic with fast-growing companies with minimal/null earnings and is
8
When computing EPS growth rates, it’s fundamental to adjust the yearly amount for non-recurring items
EBIT
9
ROIC=
Average Net Debt + Equity
Last Quarterly Dividend Per Share ×4
10
Implied Dividend Yield=
Current Share Price
EBITDA , ( EBITDA−Capex ) ,∨EBIT
11
Interest Coverage Ratio=
Interest Expense
12
Multiples are usually structured as to indicate in the numerator a measure of market valuation and in the denominator
a measure of financial performance.Moreover, the two measures must be coherent: for enterprise value multiples, the
denominator must report a measure of interest for both share- and bondholders, such as Sales, EBIT or EBITDA, while
for equity value multiples the most employed measure is earnings, which do not directly interest debt.
sensitively dependent on capital structure. Thus, most bankers rely upon enterprise
Enterprise Value
value multiples, of which the most relevant can be considered EBITDA
. Its

advantages are the independence from capital structure and D&A policies, as well as
Enterprise Value
taxes. It also shows two less employed variants, such as EBIT
(useful when

lacking of complete information on D&A or when assessing companies with high

Enterprise Value
capex) and Sales
(valuable when treating with fast-growing companies that

haven’t shown relevant profitability yet, as well as to check the evidences from the
other indicators). Finally, in Appendix C a table reports some interesting sector-
specific valuation multiples.

4) Benchmark Comparable Companies

This phase is essensial for a correct valuation of the enterprise value. The
benchmarking must not be only referred to quantitative comparison, but great
relevance is reserved to prior study of the target and its sector, as well as the story
and poritioning of each of the comparables.

Benchmarking is structured in two steps: the first one is based on Financial

Statistics and Ratios, in order to collocate orientatively the comparables in clusters
of similar size, profitability, growth, returns, and credit profile; the second one
follows Trading Multiples, in order to observe and compare the complete range of
these indicators in the comparable universe, taking into consideration the figures
referring to the most similar comparables as well as means, medians, highs and lows.

Finished the two steps, the banker can further refine the universe, excluding or
adding companies to the clusters.

5) Determine Valuation

The banker typically begins by using means and medians of the most relevant
multiples for the sector (e.g., EV/EBITDA, P/E, sector-specific multiples) to
extrapolate a defensible range of multiples, while highs and lows serve for further
guidance. That being said, the main reference is reserved to the multiples of the
closest comparables, which suggest the tightest and most appropriate range.
Moreover, part of the exercise is to decide upon which base is the most appropriate to
employ for the valuation (LTM, one-year or even two-year forward financials).
This must be chosen considering the phase of the business cycle, the sector, the
reliability and comfort with consensus estimates.

An example of valuation through Enterprise Value-to-EBITDA is reported below.

APPENDIX A (Sources of Financial Information)
 APPENDIX B (SEC filings adjustments)
Last Twelve Months Financials can be computed adding to the prior fiscal year
financials the “current stub” (that is to say the YTD 13 financials for the current year
period) and subracting the “prior stub” (YTD financials from the prior year).

Furthermore, certain companies do not report on the standard schedule (that ends on
the 31st December), but recur to a different practice. Thus, there is the need to
calendarize the figures of the filings through a standard procedure:
( Month¿)×( FYA Sales) (12−Month¿)×( NFY Sales)
Next Calendar ( CY ) Sales= +
12 12

where Month # refers to the ending month in the company’s fiscal year schedule,
FYA stands for Fiscal Year Actual and NFY for Next Fiscal Year.

Finally, it is important to eliminate the misleading effect of Non-Recurring Items

and Recent Events on the figures reported in the SEC filings. As Non-Recurring
Items can be considered as one-time charges and gains (e.g., restructuring events such
as store closings and headcount reduction, losses on asset sales, changes in
accounting principles, inventory write-offs, goodwill impairment, extinguishment of
debt, losses from litigation settlements). NRI can be typically sourced from
considerations in the MD&A section as well as from financials footnotes, if not
13
Year to date (YTD) refers to the period of time beginning the first day of the current calendar year or fiscal year up to
the current date.
explicitly broken out on separate line items. It is important to distinguish between
pre- and after-tax amounts as to correctly compute the effects of the adjustments on
the margins (EBIT and EBITDA, for instance) and on earnings. Recent Events must
also be taken into account, as operations such as M&A transactions, financing
activities, conversion of convertibles, stock splits orshare repurchases can have a
relevant impact on the reported financials for each fiscal year14.

APPENDIX C (Sector-Specific Valuation Multiples)

14
For recent M&A transaction announcements, for example, the balance sheet must be adjusted for the sources of
financing the company is willing to employ for the purchase, while the income statement must be incremented of the
amount of the target’s adjunctive sales and earnings.