Valuation of Pharmaceutical and Biotechnology Companies: Comparable Transactions Method (Part 3)

In this article the Comparable Transactions Method (CTM) is discussed. In CTM the valuation of the company is based on the answering the following question: If the company was sold are there any similar transactions have taken place under similar conditions? Could these transactions be used in a comparative manner in the valuation of the company? The following steps can be followed to accurately value the target company using CTM:

Step 1: Analysis of the Target Company

As in CMM (see here) the data needed to be collected for the target company are:

  • Location: headquarters, countries of operation, location of subsidiaries.
  • Quoted Status: Publicly Listed or Private.
  • Product Pipeline: Number of products, breakdown of products’ type.
  • Revenue structure: breakdown of revenues by area.

Step 2: Characteristics of Comparable Transactions

The CT sample should fulfill the following criteria:

  • The target company shall have a similar business description if available.
  • When researching for acquisitions (comparable transactions) the SIC code should be the same or close to our company.
  • Comparable transactions should have been completed at most 3-4 years prior to the valuation date.

Step 3: Collection of Comparable Transactions Data

Two types of data need to be collected for CT valuation. These are:

  • Transaction Financials: Price to Sales, Enterprise Value to Sales, Price to Earnings After Tax (EAT), Enterprise Value to EBIT.
  • Financials of the Company to be Valued: Sales, EAT, EBIT, Net Debt (Debt – Cash).
  • Other: Target Ownership (Public or Private), Announcement Date of Transaction, Percentage bought by bidder in each comparable transaction.

Step 4: Analysis

Before estimating the average and the median of the transaction multiples a two-fold adjustment has to be made in the equity value of the target company in each comparable transaction:

  • Discount for Lack of Marketability: If the target company in the CT sample is a private company and the company to be valued is public (or vice versa) then the equity value of the target company has to be adjusted. This occurs because a private company does not have a comparable equity value with that of a public company and that is because a public company has better liquidity and better access to the capital markets.
  • Control Premium: For each transaction in the CT sample it must be known whether the bidder has acquired a majority or a minority of the target’s equity. If it is a majority stake then the bidder paid a control premium which should be subtracted to find a realistic transaction multiple.

Since, it is almost impossible to find the discount due to lack of marketability and the control premium for each transaction an industry average can be applied (based on the industry classification code named SIC Code).

Control premiums for past transactions can be found here. For example, the SIC Code for the pharmaceutical industry is 2834. In the link attached, 14 transactions took place in the pharmaceutical industry in the first quarter of 2012. Taking the average of the control premiums of the above sample (excluding outliers) a representative control premium can be found if you are valuing a pharmaceutical company in 2013 or 2012. Typical control premiums can range between 15% – 45%.

Marketability discount can be found by looking at recent Initial Public Offerings (IPO) of companies in the relevant industry and comparing the company’s equity value pre-IPO with the market value of equity in the post-IPO period. Marketability discount varies by industry and company size but it is typically between 20% – 40%.

Therefore:

Adjusted Equity Value When Valuing a Public Company = Equity Value * (1 + a*CP + b*MD) (i)

Adjusted Equity Value When Valuing a Private Company = Equity Value * (1 + a*CP – b*MD) (ii)

  • a = 0 if the bidder buys a minority stake
  • a = 1 if the bidder buys a majority stake
  • b = 0 if the target company is public
  • b = 1 if the target company is private

If net debt is also known for each target company in the CT sample the Adjusted Enterprise Value can be estimated by adding the Adjusted Equity Value with net debt. If net debt cannot be obtained then reported (e.g. annual report) EV measures can be used.

As a final step, the transaction multiples are calculated by dividing  Adjusted Enterprise Value and adjusted equity value with the target company’s sales and EBIT and EAT. By finding the average of these ratios (excluding outliers) and multiplying by the company’s parameters the final value of the company can be obtained.

Example: CT Valuation of Sanofi (As of 31.12.2005)

Sanofi is publicly listed therefore equation (i) applies in regards to adjusted equity value.

The following CT sample 13 comparable transactions were identified (click on the picture to see numbers more clearly). A control premium of 25% and a 25% marketability discount have been applied.

Comparable Transactions Sample

Comparable Transactions Sample

The CT sample above produced the following multiples:

Comparable Transactions Multiples

Comparable Transactions Multiples

Using the CT multiples above and the Sanofi-Aventis’ financial parameters as of 31.12.2005 the market value of equity of Sanofi-Aventis is derived as follows:

Market Value of Equity Estimation - CT Approach

Market Value of Equity Estimation – CT Approach

The last step to complete the valuation process is to provide a weight for each valuation approach. DCF approach resulted in € 91,925 mn. CMM resulted in € 92,954 mn. and CT in € 100,999 mn. (press here for previous articles on DCF and CMM)

The final step of valuation is to give weights to each valuation method in order to determine the central value of the company.

CMM and CT approach will both receive equal weight of 25% while DCF will receive a weight of 50%. Therefore, the weighted market value of equity is calculated as follows:

Valuation Synthesis

Valuation Synthesis

It can be seen that the total weighted value of € 94,451 mn. diverges 10% from the actual market capitalisation of Sanofi (€ 103,656 mn.). As mentioned in Part 1 & Part 2 there are various reasons for the difference in derived values from various valuation approaches and the actual market capitalisation of a company (including: potential investors’ speculation, M&A rumors, imperfect information, short-term investments on companies’ stocks as opposed to DCF which is based on long-term free cash flows etc.)

It should be noted that the value derived is the central value. This means that sensitivity analysis was not performed to provide with a range of values. In DCF one could slightly alter the growth to perpetuity and WACC to see the potential effects on Enterprise Values. That would provide a range of values and in fact the actual market capitalisation value would lie in that range. Therefore, the derived value can be considered close to the actual market capitalisation meaning that the stock as of 31.12.2005 was not overvalued or undervalued and investors’ expectations about Sanofi-Aventis were realistic with respect to Sanofi-Aventis actual financial performance.

One thought on “Valuation of Pharmaceutical and Biotechnology Companies: Comparable Transactions Method (Part 3)

  1. demetris this is a lot of work! Great

    I usually tend to assess potential values with these different methods in order to create a volume of potential outcomes (VPO) and then I ask the evaluation team to dig into the profils and come up with scenarii for the most important development projects, and the most important marketed products, as these are necessary steps to avoid being unpleasantly surprised, while a multiple based approach could not detect evolution of key drivers.

    best.
    jl

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