Precedent Transaction Analysis Step-by-Step Guide With Examples

What is Precedent Transactions Analysis?

Precedent Transactions Analysis is a valuation method based on the premise that a company’s value can be determined using similar M&A (Mergers & Acquisitions) transactions from the past. It is one of the three main valuation methods in investment banking alongside the discounted cash flow valuation and the comparable companies valuation.

This article will walk you through all the key steps to making a precedent transactions analysis.

1. Selecting the Relevant Transactions

The first step is to select the universe of relevant transactions. But before this, you need to understand the company you want to value. You should know your company’s industry, financial metrics, geography, company size, etc. Once you have this information for the company you're looking to value, you can start the screening process of looking for comparable transactions.

A common mistake here is to focus on the buyer participating in the historic M&A transaction as you should really only focus on the target (the company being acquired). Important considerations in the screening process include:

• Industry sector
• Company size (number of employees, offices, etc.)
• Geography
• Financial metrics (revenue, EBITDA, net income, debt, etc.)
• Deal size

At this point, you’re probably wondering how you can go about finding these relevant transactions. That’s where financial data services like CapIQ or Bloomberg come in handy.

The CapIQ screenshot below shows how you can search using “transaction screening.” This allows you to filter by past transactions, and even filter by important criteria like geography, deal size, transaction date, and more.

While tools like CapIQ will facilitate this process, depending on the company you’re valuing, you may not find relevant precedent transactions. For example, a large company like Amazon has multiple business segments such as online commerce, physical stores (Wholefoods), Amazon Web Services (AWS), and more. This makes it very difficult to find relevant transactions as there are not many companies similar to Amazon and its business segments. If you’re in this scenario, precedent transactions analysis may be assigned an arbitrarily lower weight relative to other valuation methods which are likely to be more accurate.

2. Determine the Valuation Multiples

Once you have selected the past transactions, you’ll need to find the market and financial data need to spread the multiples. “Spreading” is finance lingo for inserting figures into Excel.

Common multiples to include:

1. Enterprise Value / Revenue
2. Enterprise Value / EBITDA
3. Stock Price / EPS
4. Market Capitalization / Book Value

You’ll need to find each target’s enterprise value, revenue, EBITDA, etc. You can often find this in CapIQ (paid), Bloomberg (paid), or Yahoo Finance (free). Once you have this information, you can spread the multiples by dividing the numbers to derive financial ratios or “multiples” (Ex. Enterprise Value / Revenue).

Below is an image with all the key trading multiples. To the left, we have the transaction date alongside the acquirer and target company. Then in the center, we have the three main figures we need, which are enterprise value, LTM (last 12 months) of revenue, and LTM of EBITDA. Finally, all the way to the right we have the valuation multiples. At the bottom in yellow, we have the 75^th percentile, the average, the median, and the 25^th percentile. Some financial analysts sometimes calculate the minimum and maximum multiple as well.

In this example, we have very high multiples for the fourth transaction. This is important to note as you’ll want to exclude any outliers which can skew your data. As such, investment bankers often resort to using the median instead of the average which helps remove the impact of outlier figures on the calculated multiple.

Additionally, depending on the company you are valuing, you may want to use some industry-specific multiples. For example, media companies may use EV/Subscribers or banks may use Price/Tangible Book Value.

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3. Apply the Multiples to the Company You Want to Value

Now that we've determined both the companies and the valuation multiples, we can apply the ratios to the company we want to value.

For example, if the median EV/Revenue is 3x, and the company we are trying to value has a revenue figure of $150 million, then the proposed valuation would be $450 million (3 x $150 = $450).

Similarly, on the EV/EBITDA side, if the median is 10.2x, and the company we are trying to value has an EBITDA of $40 million, then the valuation would be $408 million ($40 x 10.2 = $408).

Valuation figures are often expressed as a range instead of a specific number. For example, instead of taking the median, you may opt to take the 25th to the 75th percentile multiples, which will give you a valuation range instead of one specific number.

4. Create a Football Field (To Visualize Your Valuation Results)

Once you determine a valuation range using the precedent transactions analysis, you'll want to visualize the figures using a football field chart. This is an industry-standard visual used to illustrate company valuation ranges derived from the main valuation methods.

Common valuation methods included in a football field chart:

• Discounted cash flow analysis
• Comparable companies analysis
• President transactions analysis
• Equity research analyst estimates
• 52-week high and low (assuming it's a public company)

Unlike other valuation methods, the precedent transactions analysis often includes a control premium. This means that the acquirer had to pay a premium on top of the target’s share price if it wanted to have a controlling position (owning more than 50% of the shares).

Acquirers usually pay a control premium because the existing shareholders of the target company have no incentive to sell a majority stake at the trading price. To give the target company an incentive to sell a majority stake in the business, the acquirer has to offer a premium price. Hence the term “control premium”. As a result of the control premium, precedent transaction analysis often produces a higher valuation relative to other methods.

Pros and Cons of Precedent Transactions Analysis

Pros:

• Information is publicly available.
• Uses realistic information based on transactions that have actually happened.

Cons:

• Previous market conditions may distort valuation. Unlike the comparable companies valuation method, precedent transactions relies on historic data.
• Unique companies make it difficult to find directly comparable historic transactions.

Additional Resources

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If you want to practice valuing real companies using the main valuation methods, check out our Complete Finance & Valuation Course.

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