How should associate companies be treated in valuation work?

Answer 1

In relative valuation work we calculate an earnings stream for our target (e.g. EBITDA) and multiply that up, based on the valuation:EBITDA multiple other similar comparable companies are trading at. For example:

[10m EBITDA earnings for target] x

[average EBITDA multiple of 6 for comparables] =

60m target company valuation.

The question is, how should we treat income the target company receives from associates?

Step 1: exclude associate income for our valuation target

Associates are businesses where the owner (the target company we are trying to value) holds a small shareholding. They can be businesses that are not core to normal operations, so the temptation is to exclude associate income when calculating underlying EBITDA earnings for our valuation target.

Step 2: exclude associate income, and the value of associates, for our comparable companies

To be consistent, we will need to exclude associate income from EBITDA in comparable companies, and also remove the value of the associates from valuation, to derive an underlying valuation multiple for the core business.

Step 3: add the value of the associates to the valuation for our target company

When valuing the target business using an EBITDA multiple derived from other comparable businesses, then we will need to value the associates separately and add those to our valuation for our target.

So our target's valuation =

[EBITDA less associate income] x

[EBITDA multiple for comparable companies*] +

[Value of associates]

*where EBITDA multiple for comparable companies =

[Valuation of comparable companies, excluding value of associates] divided by

[EBITDA, less associate income, for comparable companies] This question was received on one of our valuation courses. See http://www.financialtrainingassociates.com/financialtrainingcourses.htm