Interview question in valuation

What could lead two companies with very similar financial statements to be bought at different amounts?

We consider two companies with very similar financial statements:

  • Same revenue ;
  • Same EBITDA ;
  • Same cash flow generation, etc.

Yet the two companies are not valued in the same way at all. Why is this?

Valorisation d'entreprise

Calculating value: the historical performance is not everything

The historical accounts of a company are critical (especially when it has reached a certain level of maturity).

Nevertheless, a financial valuation is not only based on a company’s financial history but on its future capacity to perform and generate cash flows.

Indeed, one wants to know how the company is doing today and how it will evolve in the coming years.

Then, although the two companies have similar financial statements today, it is enough for one of the two companies to have better growth and profitability prospects for the valuation of the two companies to be different.
In this case, in addition to the history, we will study the following:

  • The markets in which the two companies operate (one of them may have better prospects)
  • Competitive advantages, positioning, etc.
  • The experience and vision of the management
  • The business plan: the prospects of both companies
  • Growth strategy, etc.

Value is all well and good, but what about price?

Before continuing, a reminder is in order:

  • The notions of value and price are quite different.
  • Value results from a theoretical exercise, a calculation, a comparison, etc.
  • The price is simply what a buyer pays to acquire something.
  • => In fine, the price can be higher or lower than the value.

Let’s go back to our two nearly identical companies. Why are they valued differently, and why can the price also differ?

External factors also condition an investment or a buyout. These factors can be :

  • Particular market situations
  • An auction that one or more buyers pull up
  • A buyer who is aware that his offer is high but does not want to miss the deal (because he has identified a technology, know-how, or resource that he wants)
  • Negotiations that turn to the advantage of the seller

Conclusion:

The valuation process is not automatic and is based on long due diligence on the target and its market.

Estimating a value is one thing, but in reality, the transaction can be carried out at a very different price than the one calculated on an Excel spreadsheet.

🍫 So here is why the right Twix company can be bought for much more than the left one!

The process of studying a target in Private Equity, M&A, and Transaction Services, as well as all the major valuation approaches, are detailed in our training courses. Find them on our home page.

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