Feb 23, 2024  12:14 AM

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The source data that Cogent Valuation utilizes in its transaction database is from publicly available sources, primarily the filings of public companies acquiring private companies.  What makes the Cogent M&A database unique is the substantial volume of data culled from each transaction and the internally developed normalization procedures that are employed to enhance consistency and make the data most usable for valuation purposes.  What follows is an explanation of the most significant of those procedures.

Purchase Price

In the Cogent Database, each component of the purchase price is separately quantified.  This allows the user to identify and screen for only certain types of transaction (e.g. cash only transactions) as well as to identify and adjust for differences in transaction type (e.g. to adjust stock transactions downward relative to cash transactions).  To achieve this breakdown, the purchase price is separated into the following categories:
  • Cash paid to sellers
  • Common stock of acquiring company issued to sellers
  • Preferred stock of acquiring company issued to sellers
  • Promissory notes issued to sellers
  • Target company pre-transaction interest-bearing debt assumed by acquirer
  • Earn-outs and other forms of contingent payment
Common Stock:  The acquiring company’s common stock paid to sellers is valued at its market closing price on the date of the transaction.  No discounts are taken for lock-ups and Rule 144 restrictions.  Stock options and warrants issued to sellers are not included. 

Preferred Stock:  Acquiring company preferred stock issued by the acquiring company to the sellers in connection with the transaction is valued at the face amount.

Purchase Notes:  Promissory notes issued by the acquiring company to the sellers in connection with the transaction are valued at their face amount.

Interest-Bearing Debt (IBD) Assumed:  If the transaction description specifically discloses the amount of interest-bearing debt of the target company that was assumed by the acquirer in the transaction, this figure is used.  If the transaction description is silent on debt assumption, it is assumed to be zero in the case of an asset sale and assumed to be equal to the interest-bearing debt on the target’s balance sheet for the most recent reported quarter in the case of a stock sale. 

Contingent Payments:  Contingent payments or earn-outs are quantified at their maximum amount for information purposes only but are not included in the market value of invested capital (MVIC) or market value of equity (MVE) indications upon which the acquisition multiples are based.

Revenue and Earnings Normalization

The single most beneficial feature of the Cogent M&A Database is the substantial effort that is put into each transaction to make the appropriate adjustments to normalize the earnings.  The resulting normalized earnings is a much better indicator than reported earnings of the “representative level” of earnings upon which the acquirer made its purchase price determination. 

The following are the most significant of the normalization procedures employed by Cogent Valuation to adjust reported revenue and earnings on the income statement:
  • If provided, Cogent Valuation uses pro forma, rather than reported, income statements because these typically exclude operating results for business operations or assets that are not included in the sale and reflect other appropriate adjustments to reported results to make them more representative of what the acquirer received in the sale. 
  • Non-recurring or extraordinary income or expense items—e.g. gains and losses, restructuring charges, impairment charges, legal settlements, write-offs--are added to or subtracted from reported operating results (the majority of the time these will not appear directly on the income statement but will have to be found by a careful scrutiny of the notes to the financial statements or the cash flow statement).
  • When such information is provided, a representative level of owners’ compensation is substituted for actual historical levels of owners’ compensation.
  • Amortization of intangibles from the target’s previous acquisitions is added back to earnings and subtracted from depreciation and amortization because it is a non-cash charge that artificially lowers earnings and, unlike depreciation, is not a proxy for ongoing capital expenditure requirements.
  • Depreciation expense is taken from the cash flow statement, not the income statement because the income statement often understates depreciation.  Likewise, interest expense is taken from either the cash flow statement or the notes to the financial statements rather than the income statement if the income statement shows interest expense net of interest income.
  • Both the purchase price and the financial results for foreign acquisitions are reported in U.S. dollars.  The exchange rate is the actual exchange rate on the date of the transaction for purchase price, the date of the end of the reporting period for balance sheet items, and the daily average throughout the period for income statement items.
  • All normalization adjustments to reported net income are income tax effected at a 40 percent tax rate. 

Tax status: Target companies are designated as either a “C-corporation” or a “pass thru entity”.  Pass thru entities include S-corporations, general partnerships, limited partnerships or limited liability companies.  If this information is not disclosed in the source data, Cogent infers the target company’s tax status from its historical income tax rates. 

For pass-thru entities (S Corps, partnerships and limited liability companies), a 40 percent tax rate is applied to net income in order to derive net income on a Corp-equivalent basis.  Therefore, market multiples of net income and cash flow will be stated on a C Corp. equivalent basis.

Balance Sheet

For stock purchases, balance sheet items are entered from the target company’s most recent balance sheet.  For asset purchases, the pro forma balance sheet is used to capture only the assets and liabilities purchased by the acquirer. 

Target Acquisition Multiples

A common problem with market multiples from M&A transaction databases is that there is a mismatch between the capital structure represented by the purchase price in the numerator and the earnings level in the denominator.  For example, if the target company has historically had debt but the debt was paid off in connection with the transaction, the historical reported net income will understate netincome going forward be the inclusion of interest expense that will not continue and the resulting P/E multiple will be overstated. 

Market multiples are expressed with one of two figures in the denominator: market value of invested capital (MVIC), or market value of equity (MVE).  The mismatch problem occurs with market multiples based on MVE (as opposed to MVIC) and is addressed by the normalization procedures set forth below. 

Multiples based on Market Value of Invested Capital (MVIC): Market value of invested capital (MVIC) is the total purchase price excluding contingent payments—cash paid to sellers, acquiring company common stock, acquiring company preferred stock, seller notes, and interest-bearing debt assumed by the acquirer.  It represents the value of the target on a “debt-free” basis.  When they are applied to the subject company’s earnings levels, multiples based on MVIC result in value indications for the company as if it had no debt.  The subject company’s actual interest-bearing debt must then be subtracted from the MVIC value indication in order to arrive at its equity value.  MVIC multiples are applied to earnings levels that are BEFORE payment of interest to debt-holders.  These include: MVIC to revenues; MVIC to gross profit, MVIC to earnings before interest taxes depreciation and amortization (EBITDA), and MVIC to earnings before interest and taxes (EBIT).

Multiples based on Market Value of Equity (MVE):  Market value of equity (MVE) represents the purchase price for the target company’s equity, net of its interest-bearing debt.  MVE multiples are applied to earnings levels that are AFTER payment of interest to debt-holders.  These include: MVE to pretax earnings, MVE to pretax cash flow, MVE to aftertax earnings, and MVE to aftertax cash flow. 

In order to provide meaningful MVE multiples, our database treats stock purchases differently than asset purchases.   When the acquirer is acquiring the target company’s stock (a stock purchase), the cash and securities paid to the sellers are assumed to represent an amount paid for only the equity because the target’s debt will typically not be repaid in connection with the transaction.  Thus, MVE represents the portion of the purchase price that includes cash paid to sellers, common stock of the acquirer, preferred stock of the acquirer, and seller notes.  However, when the acquirer is acquiring the target company’s assets (an asset purchase), a portion of the cash and securities paid to the sellers will often be used to retire the target’s interest bearing debt.  This alteration of the capital structure results in the mismatch problem referenced above.  Thus, for asset purchases the MVE multiples in our report will come back as “N/A” to avoid any misleading results.

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