While taking exit multiple to calculate terminal value of the company we can also take help from at what median multiples do our peer group trades.
Peer group does not mean companies which belong to same industry it rather means that companies have similar business characteristics. Some of the factors that should comparable in peer are as follows:
Sources of Revenue Generation/Business Model
Sales growth & scale
Asset intensity and
Leverage like Debt to Equity (D/E)
It seems so easy on the face of it that it has become a gold standard for valuations across the globe but let's check below how even in such simple cases an analyst might get stuck.
Let's look at some real life scenarios where applying peer group valuation multiple become tedious.
1. Dhanuka Vs PI Industries - Business Model Segment difference
Even though Dhanuka & PI optically looks to be comparable businesses that's only true for domestic segment. In abundant reports we have read people comparing valuations Gap between the both but they miss a simple point - Right from the point of Revenue generation source to opportunity size available for growth to Capex requirements both businesses are poles apart. Hence, Market won't rationally assign same valuation multiples to both the business.
In some reports we have seen comparison between Bharat Rasayan, Dhanuka & PI Industries. That's becomes even more absurd as Bharat Rasayan operates in different portion of Value Chain (preparing intermediates) VS Dhanuka & PI focusing mainly on formulations. The industry structure in terms of bargaining power of buyer, Entry Barriers are way different for Bharat Rasayan Vs like of Dhanuka & PI.
Note: This example is not to explain any business model is better than other it's just to put a simple point that a simple cut-copy-paste of valuation multiples between businesses is a crime that an analyst should never commit.
2. Two and Three wheeler auto industry
On the face of it it seems the industry with limited number of players and hence easy to understand multiples awarded to companies by the market. But let's look at the revenue break up and try to understand the issues that arise. See the table below:
Basically, no company seems comparable to one another even of basic things like Revenue contribution & geographical dependence.
3. Delta Corp (only listed company in casino gaming)
It is very difficult to find it's peers because of quasi Monopoly due to regulatory licenses i.e. Government rate of giving approval for casino license is very low. Check out below link where you can find Number of States in which Government has given Casino license. There are only 3 states with a total of just 20 licenses to run Legal Casino business in India. More important part is it is the only listed player in India making relative peer multiple analysis impossible.
The above image explains that Cement as an Industry is a business of scale (Economies of scale) and Operational efficiency. If your company has reached a certain level of scale maintaining/improving operational metrics like EBITDA/Ton etc then market will offer a high multiple compared to other players.
Note: The outliers are Prism, Birla, Dalmia, ACC and Ambuja. Prism has single digit Op Margin and huge debt. ACC and Ambuja were having merger issues at that time. The odd men out are only Birla and Dalmia.
So in cement you will have to find a sub-set within your peer group (geographical presence) to truly apply peer multiple strategy.
Hence conducting a relevant peer groups based exit multiple exercise requires quite a decent effort.
Note: Please do also read good case studies here on the problem with relative valuations
Read our next blog to understand Exit Multiples through the transaction method or DOWNLOAD Our Terminal value master PDF.