Confessions of a Corporate Dealmaker

Valuation - Data Sources

Here is another email question from last week's Valuation series.  Bill is wondering where I find the data that I use for valuations?

Here's what I like to use, and please send comments if you know of any better sources, uses or ideas.

Public Comps - The first task is to find the right comps to use.  I use EdgarPro to do keyword searches on SEC filings.  I use key business words or descriptions but also look for filings where companies list their competitors.  I like that because if another company lists the target as a competitor, it's pretty hard to argue it out of the analysis.  I also use OneSource or Hoover's for competitor lists.  Google is a good tool to use as well, because most companies buy their competitor's names and products as AdWords.  To get the numbers to build the comp table, I like to go back to EdgarPro and download financial data into Excel.  I have also used Capital IQ to build quick and dirty comp tables, and it seems pretty accurate.  However, I like to touch the data and build the table myself, so EdgarPro works well for me.  I also use EdgarPro to search for fairness opinions to see what other deals have used as comparables and pre-acqs.

Precedent Acquisitions - I don't like to use the M&A databases that are out their, as I only look for a few quality matches.  Finding the deals is hard, but I find that most of the above-mentioned tools are good for sleuthing them out if you set the searches to go far enough back.  However, probably the best tool is VentureSource.  I use VentureSource to do a keyword search on industry or product names and then pick out the list of acquired companies.  Now the hard part is finding the data on these deals.  Some of the data, typically only total consideration, are usually disclosed in press releases or in 10-Q's, but the best place to mine for gold nuggets like revenue or EBITDA of the target is conference calls.  I use StreetEvents to search text of the calls to find this data.  These calls are full of data, and I use the transcripts to document my numbers.  I also use D&B to get financial data on private companies that have been acquired.

I always check VentureSource to see if I can find valuations of a target's financing rounds and to see how much money they've raised.  I also really like Factiva to search for news articles, especially stories comparing products or services.  I like finding the news about the target that doesn't show up on its Web site.

Valuation - Proprietary Deal Data

Since it's Friday, let's clean up the email bag with an answer to a valuation question.

Matt from New York writes that a few years ago he sold his company and the banker representing the acquirer used several merger comps, or precedent acquisitions, that the banker said were proprietary.  Proprietary in this case meant that the investment bank had done those transactions, so they obviously knew the multiples even though the terms of the deals were not disclosed to the public.  Matt is wondering if he was taken after reading my post about requiring documentation for pre-acqs.

Well Matt you probably didn't get taken, as I know the firm you mentioned and several people that work there and all have excellent reputations.  Plus Matt did the right thing by confirming that the bank did do those transactions.  Here are a few things you can do next time.

1. Weigh the Impact.  If the multiples of the proprietary comps are all at the high end, then you may have some problems.  If not, better to just let it go.
2. Get it in Writing.  Ask for letters from the represented parties to the transactions, confirming the multiples.  The acquirer's banker should be able and willing to get these.
3. Call the Bankers on the Other Sides.  The bankers on the other sides of the proprietary deals might be willing to confirm the multiples.  Your banker probably has contacts at those firms and can find out.

Valuation Round VI - Projections

Well yesterday's post has certainly been the most controversial to date.  I received a lot of emails today from readers, or maybe former readers, complaining that my tactics to "bust-up" a target's DCF analysis are "dishonest", "deceiving" or "unethical."  One reader mentioned that, "It's just a poor way to start the deal process by tricking the seller ... and doesn't build any positive goodwill going forward."  On the positive side, I'm apparently qualified to work at Gitmo (see the Comment on the post) and a very nice Excel Product Manager from Microsoft emailed to thank me for the input on manual recalc, as they are considering taking the feature out - seems no one's been using it but me.  It's amazing how blogs travel!

I don't feel like the tactics I use are meant to deceive.  I use manual recalc to simply get the selling team to focus on the granular aspects of their projection assumptions without being jaded by the end result.  What's ironic is that I'm really trying to get to the truth.  I worked in investment banking too long and saw too many DCF's reverse-engineered to achieve a pre-destined result.  Meetings like this are hard, and they often end in an uncomfortable way with the sellers feeling angry and/or embarrassed.  But I don't rub it in anybody's nose; there are no fist-pumps or high-fives on my side.  I try to act professional and treat people with respect and dignity.

I don't like having to use tactics like this, but in every acquisition I've seen, the projections were "hockey sticked".  While in almost every case post-deal revenue went down instead.  Hugh McColl always assumed that 30% of the acquired revenue would walk.  Without that assumption going in, he said the deals would have never worked.  Besides, if your projections were realistic, why would you be selling?  By the way, don't embarrass yourself by justifying your projections based on what your company could achieve as part of my company.  I don't pay for synergies that I have to make happen.

Valuation Round VI - DCF

Using some flavor of discounted cash flow to value an acquisition is by far my least favorite method.  Don't get me wrong, DCF is quite handy and preferred for doing most valuations related to ongoing business operations.  But sellers always use DCF based on projections to determine value.  It's the projections, not the DCF, that are always wrong and always wrong in the wrong direction (we'll deal with projections tomorrow).  In an acquisition, the only DCF I care about is the one I create to justify that the acquisition is more economical than building it in-house.

Note to Investment Bankers: I just flipped through a couple dozen valuation books that I've received over the last few years, and the average number of Excel sheets devoted to DCF is seven (not including projections and assumptions) with the low being two and the high being a remarkable 23.  Then I was able to calculate one of the DCF's on my HP 17b.  The point is no one needs to see seven pages of this stuff.  One sheet is perfect, two is acceptable.

Here's how I bust-up your DCF.  After reviewing your banker's seven pages of DCF calculations, I complain that I just don't understand how the DCF works thereby requesting an electronic copy of it and your projections.  Then I call back and say that the DCF looks great, but I'd like to meet to go over your projection assumptions, as I have several questions.

The work I do prior to the meeting is to change your projections and watch how the changes impact the DCF.  The trick I do prior to the meeting is to change my Excel, so I have to manually recalculate formulas (Tools, Options, Calculations).  Hitting the F9 key recalculates, but to only recalculate the active sheet hold the Shift key while pressing F9.

When we meet I suggest that we make any changes (I put your projections back to their original form for the meeting) in real-time using my laptop and a projector.  During the meeting I attack your projections, assumption by assumption, making small, subtle changes, as I know which areas to hit and how far to hit them.  But it's most important that I get you to agree with the changes (since most CEOs know that the projections are BS this isn't that hard).  You can't see the impact because Excel isn't recalculating the formulas.  If you inquire about this strange phenomena, I simply say that there is something wrong with my Excel, and we'll I have to recalculate all the formulas at the end.  When that happens, F9 is not your friend.

Valuation Round V - Pre-Acq

Precedent acquisition analysis is my favorite valuation method.  I'm not sure why.  Maybe it's because I can always find two or three golden nuggets, or maybe it's because it takes a lot of research and sleuthing to find the numbers.  Using a pre-acq has its detractors.  They say that the information is stale, no two deals are alike, the numbers are incomplete or why base valuation on past deals when at least half were incorrect.  I still think that a pre-acq done right and in the right context is a valuable tool.  Most buyers don't use pre-acqs.  I usually use them defensively and then offensively.

Most pre-acqs I see were prepared by an investment bank and include 15 - 20 deals.  The deals were pulled from special third-party databases by entering a lot of specific parameters like SIC code, country, industry, keywords, size, etc.  This spits out about 100 deals which are narrowed, as more than half the deals lacked any data and the others "just didn't fit".  So when you present this to me I focus on the parameters, and after a discussion will probably agree with your parameter selection.  Now show me the "just didn't fits".  This usually causes some fidgeting and your banker explaining that they're not relevant so they weren't included.  Great, let's call that I-banking analyst and have him/her rerun the whole thing and send it right over.  When I get the spread sheet, I find that many of the "just didn't fits" actually do fit pretty well and plenty of the 15 - 20 don't really fit at all.  This exercise always causes the multiples to decrease dramatically.

Don't wast your time with these databases.  It's the wrong approach completely.  With pre-acqs less is more.  All you need are two to four high-quality matches to make a case, and you probably know off the top of your head which deals those are.  Then spend your time building intelligence around these matches, so you can make a strong argument as to why they're a good fit.  If these matches are too low for your valuation expectations, deal with in a realistic and honest way.

The second mistake is lack of documentation.  VCs try this a lot, and I've seen some buyers go along with it.  When I get list of merger comps with acquisition multiples, I always ask to see the documentation - database sources, press releases, SEC filings, conference call transcripts, etc.  The majority of time there isn't any.  Sometimes this information just needs to be found, but often it isn't documentable.  If you can't prove it, I wont use it.  The funny thing is that a lot of the information is out there, you just have to take the time and know how to find it.

I once represented a buyer who was looking to make a defensive acquisition of a target whose two primary competitors had been acquired within the last 18 months.  All three companies (target plus two competitors) were private and the leaders in their segment.  In this case a pre-acq with only  the competitors was not only important but crucial; however, not enough information was initially disclosed.  Our valuation discussions were pretty far off, but after a week of digging I was able to find enough data to connect the dots and come up with documentable multiples.  This was very compelling information to the target, whose banker presented 32 precedent acquisitions to back their valuation.  We ended up doing the deal at a premium to our pre-acq multiples but for far less than the original value the target wanted.

Valuation Round IV - Public Comps

The three most often used valuation methods for acquisitions are public comparables, precedent acquisitions and discounted cash flow.  Remember, my two most important rules in valuation are to build a case for your argument and to do so using intelligence rather than just data.  We'll focus on public comps in this post and hit the other two methods later this week.  Public comps are the simplest to calculate and understand but are often used in a manner that violates my aforementioned rules.

Valuation meetings often get a bit rambunctious.  I always come extremely prepared, so should you, but sellers seldom do.  I always stay extremely calm, so should you, but entrepreneurs never do.  I watch closely how you negotiate valuation, as it's a good barometer on how you'll handle the rest of the deal.  If you become irrational and pull a Howard Dean, the deal will probably die, as I don't need to put up with that for the next few months.  If the meeting is not going well for you, control your emotions, take a break to regroup, come back and collect as much information as you can about my case and then say you need a few days to think about it.  Then decide if you can build a better case with intelligence applied to your data.  I'm always happy to meet with you again.

Here's is the mistake most often made with public comps.  You and you banker pick a handful of publicly-traded companies that you both feel are the best proxies for your company as a listed entity.  Oh, actually you don't, you simply pick a bunch of high-fliers and average their trading multiples, but you leave it at that.  Your picks are usually about 50x your size and chances are you rarely face or win against them.  What you do wrong is to leave out the low-liers and assume I don't know about them.  But remember I came extremely prepared and know a lot about both the high-fliers and the low-liers.  I not only know all their trading multiples, but I also have other intelligence like growth rates, win frequencies, strength in verticals, revenue per employee, R&D spends, strategies, etc.  And I'm ready to discuss how those compare to your company.  At this point CEOs usually give a speech about how the low-liers couldn't hold a candle to their company and that they win every time they face the low-liers.  Fine, get your Sales VP on the speaker phone and tell him/her that I'm from your auditing firm and what to discuss your year-to-date pipeline to find out who you competed, won and lost against.  I've yet to have a taker on that one.  This is the point in the meeting where CEOs usually go a little Howard Dean on me.

Valuation Round III - How the Buyers Do It

Since it's Friday afternoon and I'm sick of hearing myself write, I thought I would give an inside look at how two of the largest and most active technology acquirers view valuation.

First up is Brian Roberts former VP and head of Microsoft's Global corporate development organization.  Brian is now with San Francisco-based Evercore Partners and is a good guy to boot.

CCD: Brian, MSFT completed over 50 acquisitions while you ran corporate development, how did you approach valuing targets?

BR: We used a combination of techniques and then applied judgment to form a valuation opinion of a company or asset.

CCD: Which techniques did you use?

BR: One of the most powerful techniques used was to develop a free cash-flow differential between the buy and build cases.  We then could value the discounted cash flow benefit of the acquisition vs. standalone cases.

CCD: There certainly must have been cases where the cost of building would have been difficult to calculate or just too restrictive? 

BR: Even in situations where we did not plan to build, creating the analytical framework often improved our understanding of the technical, marketing and sales requirements and could even impact the stand-alone valuation of the target.

Second is a recent quote from the EVP of Corporate Development at a $7 billion Silicon Valley tech company which is also an active acquirer:

For acquisitions valued at $300 million or less, ... we determine what the valuation would be if the business went public and then apply a 20% discount.  Our own [trading] multiples become the ceiling on what we're looking to pay out there.

Valuation Round II - Intelligence vs. Data

The most important thing you should remember about valuation is that to be successful you must build a case around intelligence and not just data.  Commodity pricing is based upon data, but business value is subjective - what's worth something to me is worth something else to someone else.  Data is important, but it can't support a valuation alone.  Besides, I know how to make the data work in my favor.  Despite this, I have sat through countless meetings with potential targets whose owners say, "I'm worth $X because that's were some other companies in my industry trade," or "my company is worth $X because someone else paid a certain multiple for a similar company."  Better yet is when a seller says, "We feel really confident that we're worth at least $x," and that's it, no explanation, no data points, nothing at all.  My favorite though, and this happens a lot, is when entrepreneurs say, "I have no idea what my company is worth, but I'd never sell for less than $X!"  Now what am I suppose to do with that statement?

I think you are making a big mistake when you rely solely on standard business valuation techniques to determine your company's worth in an acquisition.  Most of these methods were developed for ongoing business valuation events like taxes, ESOPs, splits, etc.  They're not appropriate for determining value in a change of ownership and can't stand up to the scrutiny that I put on them.

Be smart and be ready - have three to five pieces of intelligence ready to discus with passion and the valuation data to tie to it.  Good examples that I've seen are:

1. A CEO used three separate research report metrics (based on actual historical data) to show increasing adoption rates for a new product due to the convergence in two of the metrics and a fall-off in the third.  Her thesis was that the company was well-positioned to take advantage of these three trends and backed it up with revenue data that showed increase sales into that market.  Beyond that, she showed emails from several new clients confirming the research data as the primary driver to purchase.  She went further and showed her SFA reports detailing an increasing pipeline of similar potential clients in various stages.  Then she says sheepishly, "Because of this, we're kinda lookin' to sell at the top of the multiple range."  Of course when I pressed her she knew the exact range.  She got her money.
2. I represented an acquirer in talks with start-up that had a very disruptive technology and a passionately aggressive founder/CEO.  When we met with him to discuss what it would take to sell his company, he simply pulled out a sheet listing all the sales deals they had lost that year.  It was an impressive list - Fortune 500 buyers and A-list competitors.  It told me that these guys could play with the bigs.  Then he handed us a stack of printed emails.  With each loss he had asked the decision maker to rank their product vs. the competition and give details as to why they had lost.  In almost every case, his product ranked #1, but they always lost due to a lack of sufficient integration resources, account management and product support.  He then showed me that he was about to close on another funding round - his largest yet.  He understood that his company's weaknesses were my client's strengths, but he also knew how much it would cost for my client to build his product and how much it would cost him to build-out his weaknesses.  He also got his money and then some, but he never once pulled out a comp table or a DCF.

Valuation - Round I

Your company is always worth more to you and your shareholders than it is to me.  Beyond the intangibles of that statement - yes you birthed it, stood by it through all the ups and downs, yes, yes blood, sweat and tears, yeah I got all of that, and no none of it factors into the valuation - there is a tangible aspect that you probably don't realize.

First on the intangibles - pride of ownership is great, but it doesn't pay the bills.  Now you know that, so be reasonable and leave it out of the valuation.  Enough said.

The tangible part of the statement is this - when you sell your company the total consideration less your selling costs is what you and your shareholders get, not including the impact of taxes of course.  However, when I buy a company, the total consideration plus my transaction costs are only part of my total investment in making the deal a success.  Integration tends to be very expensive.  Whether it's technology platforms that have to be upgraded or replaced, rich severance or compensation contracts that survive the transaction, excess space or equipment under a long-term leases or even simple HR issues, it all adds up quickly.  I don't necessarily net these off the top, but I do take them into consideration the same way I consider the amount of synergies I can achieve from the transaction.  In all of your operational planning you should always ask yourself, "Is this going to make my company easier and less costly to integrate."

Valuation & Projections

Today I will start a new series on valuation and projections.  The goal of this series is to provide a better understanding of how corporate acquirers value transactions, and how you can plant seeds today that will make your company more valuable to both of us in the future.  Let me start by making some clear statements about valuation, which we'll explore further in the coming weeks:

• Sellers always value their company, where as I (the corporate buyer) always value the transaction.  The two can be very different - I'll explain why.
• Traditional valuation methods (DCF, precedent acquisitions, public comparables) are more relevant for raising money than for selling your company.  I'll show the methods that most corporate buyers use.
• In terms of projections, past performance is always indicative of future returns.  Leave the hockey sticks at the rink.  I'll explain how you can give me projections I can believe.
• Understand your cap table and liquidation preferences relative to your valuation, and make sure that your shareholders' valuation expectations are aligned (Review your drag-alongs!).
• Lean companies are always more valuable to me, as I never pay for synergies.
• The most important thing I'll write about is how to build a strong valuation case based on providing me real and relevant intelligence vs. data.