Comparable Companies in a Deal: Reading Someone Else's Price

A comparable set places one purchase price beside other prices and does nothing else. A comparable set cannot say what a price becomes once the documents settle. The purchase worked here, carrying an earn-out, already produces six honest multiples running from 9.10 times to 10.55 times, so any set recording one figure has quietly picked a numerator and a denominator on the reader's behalf.

Somebody slides a sheet across the table. On it are eight purchases in the same trade, each with a multiple printed beside it, and the purchase under negotiation sits comfortably in the middle of the range. The instinct is relief. The number looks ordinary, so the number must be ordinary. The instinct deserves a minute's delay. A list of multiples is a far thinner object than it looks, and exactly how thin is worth working out.

Here is the everyday version, and it is worth carrying through this guide. A shopkeeper is taking a shop on rent in a mall, and asks around. Four other shopkeepers on the same floor say what they pay. Four rents establish something real: whether the shopkeeper's rent sits high, low or in the middle of that floor. The four rents establish nothing at all about why any one of them is what it is. One of them signed before the mall filled up. One of them took a smaller unit with a bigger frontage. One of them agreed to a rent that rises every year and one agreed to a rent that does not. Asked what they pay, each of them gives the headline monthly figure. The headline is the figure people quote, and it leaves out the deposit, the maintenance charge and the six months rent free at the start. The four numbers position that shopkeeper without explaining that shopkeeper, and the gap between positioning and explaining is the whole subject of this guide.

Harivansh Packaging Limited, an invented listed maker of rigid and flexible packaging, has agreed to buy the whole of Sundarban Polymers Private Limited, an invented unlisted maker of flexible packaging films. The agreed enterprise value is Rs 1,320 crore. Sundarban Polymers earned Rs 132 crore of earnings before interest, tax, depreciation and amortisation (EBITDA) in its last full year, so the agreed price is 10.0 times that figure. Devyani Kulkarni is the chief financial officer of Harivansh Packaging Limited and Ashwin Rege leads the transaction team. How a multiple is put together and how a set of comparable businesses is assembled are both settled under valuation and are taken as established here. The harder question is which figures go into a multiple once real documents exist.

What does a comparable set actually establish about a purchase?

State the service narrowly. The whole trouble starts when the service is stated broadly. A comparable setA list of other transactions or other listed businesses, each with a valuation multiple beside it, gathered so that one price can be placed against them. takes one price and shows where it sits among other prices struck for other businesses. Positioning a price is a real service and a useful one. Without it, a number floats: Rs 1,320 crore means nothing on its own and 10.0 times means very little more. With it, the number has neighbours, and a number with neighbours is a number that can be discussed.

A comparable set answers where, and it never answers why. It establishes that this purchase sits toward the middle of a group, or above it, or below it. A set does not establish that the middle of the group is a sensible place to be. Nor does a set establish what any of the other buyers thought they were getting. A set carries prices, not businesses, so it establishes nothing about whether the businesses behind those other prices resemble Sundarban Polymers in any way that matters. The moment a set is asked to explain rather than to position, it is being asked for something it does not hold.

The other marks on that scale carry no numbers, and a blank mark is more honest than a figure whose source nobody can name. A number that cannot be traced to a document somebody can point at does not belong in a set that claims discipline about numbers.

What can a comparable set never establish?

A set is built from what gets published, and what gets published is the headline. The headline for this purchase is Rs 1,320 crore of enterprise value at 10.0 times EBITDA, and that figure is true on the day it is announced. The headline is also the figure with the least contact with the money that eventually moves.

Three things sit inside the agreement for this purchase, and none of them is visible to anybody compiling a list from the outside. The working capital peg is set at a normalised Rs 96 crore, and actual working capital at completion is Rs 108 crore, so the price adjusts up by Rs 12 crore. The transaction assumed net debt of Rs 180 crore, and actual net debt at completion is Rs 195 crore, so the price adjusts down by Rs 15 crore. A further Rs 60 crore is payable if Sundarban Polymers reaches Rs 145 crore of EBITDA in the first year after completion. Headline figures are what get published, so a set is struck on headline figures. The clauses that actually move the money sit in a document nobody outside the transaction reads.

Back to the mall. The four neighbours quoted their monthly rent. Not one of them mentioned the deposit, and one of them is sitting on nine months of free fit-out period that made the first year cost half of what the headline says. None of them gave a wrong number. Each of them gave the number people quote, and the number people quote is a different thing from the number people pay.

Which enterprise value goes into the numerator?

Now the first of the two named problems. A transaction multipleA price expressed as a ratio, most often enterprise value divided by EBITDA, so that purchases of different sizes can be lined up against each other. needs a numeratorThe figure on top of a ratio. In an enterprise value to EBITDA multiple it is the enterprise value., and this purchase has three of them. Not three estimates of one true figure. Three actual amounts, each attached to a different moment, each one arithmetically correct and each one answering a different question.

The first is enterprise value at signingThe enterprise value fixed by the agreement on the day it is signed, before any completion adjustment is worked out.. The equity value agreed with the sellers is Rs 1,140 crore, and the buyer assumes net debt of Rs 180 crore, so enterprise value is Rs 1,320 crore. Rs 1,320 crore is the announced figure and the one that reaches the outside world.

The second is enterprise value at completionThe enterprise value once the completion adjustments defined in the agreement have been computed and applied to the price.. The equity value actually paid is Rs 1,140 crore plus Rs 12 crore for the working capital delivered above the peg, less Rs 15 crore for the net debt above the assumed level. The arithmetic gives Rs 1,137 crore. The net debt actually assumed is Rs 195 crore. Add them and enterprise value is Rs 1,332 crore. A number that reconciles two ways is a number that can be defended, so check the same figure from the other direction. Rs 1,320 crore at signing plus the Rs 12 crore of working capital delivered above the agreed level is the same Rs 1,332 crore. The Rs 15 crore came off the equity cheque and went straight back on as extra debt assumed, so it cancels inside the enterprise value while remaining very real to the sellers, who received Rs 15 crore less.

The third is maximum enterprise valueThe enterprise value if every conditional amount in the agreement is eventually paid in full.. Add the Rs 60 crore earn-out to the completion figures and equity value becomes Rs 1,197 crore, net debt stays at the Rs 195 crore actually assumed, and enterprise value is Rs 1,392 crore. All three of those are real numbers about the same purchase, and they are not a range of estimates around a true value that somebody has failed to pin down.

The cancellation is where readers slip. The sellers are Rs 15 crore worse off than they expected. The buyer has taken on Rs 15 crore more debt to service, so the buyer is not Rs 15 crore better off in enterprise value terms. Nothing was created and nothing vanished. The Rs 15 crore moved from one side of the bridge to the other. Purchase price mechanics treats the equity side in its own right for exactly this reason, rather than leaving it inside an enterprise value figure.

Which EBITDA goes into the denominator?

Now the second named problem, and it is the one that catches careful people. A multiple also needs a denominatorThe figure underneath a ratio. In an enterprise value to EBITDA multiple it is the EBITDA., and this purchase has two in play. Sundarban Polymers Private Limited earned Rs 132 crore of EBITDA in its last full year. The earn-out turns on Rs 145 crore of EBITDA in the first year after completion. Rs 145 crore is 9.8 per cent above what the business earned.

Put those side by side and something uncomfortable appears. Rs 132 crore and Rs 145 crore are not two versions of the same kind of thing at all: one is a fact about a year that has finished and the other is a condition attached to a payment that may never be made. The first was reported, examined during diligence and argued over line by line. The second was never earned by anybody. Rs 145 crore is a number two parties wrote into a clause because they disagreed about what the business would do next, and the earn-out is how that disagreement got parked rather than resolved.

Here is the household version. A cousin sells a tempo he uses for deliveries. He says it earns Rs 40,000/- a month, and last year it did. He also says it will earn Rs 46,000/- once the new road opens, and he wants to be paid extra if it does. The two divisions produce two different sentences about the same tempo, so describing the price paid as a number of months of earnings requires saying which monthly figure was divided by. Nobody would confuse the two in a conversation about a tempo. In a spreadsheet full of transactions, people do it constantly.

The choice between the two figures is a decision rather than a preference. Name the question first and the two figures stop competing. If the question is what this purchase cost against what the business had already proved it could earn, the denominator is Rs 132 crore and there is no argument. If the question is what the buyer would be paying if the business delivers what the earn-out demands, the denominator is Rs 145 crore and again there is no argument. The numerator and the denominator both follow from the question, never the other way round. The failure worth naming is what happens when somebody picks the figures first and lets the question take care of itself.

How many honest multiples does one purchase produce?

Multiply the two problems together and count. Three numerators against two denominators is six multiples, and every one of the six is arithmetically correct for this purchase. Work them rather than reading them.

Rs 1,320 crore over Rs 132 crore is 10.00 times, and that is the headline the transaction was struck on. Rs 1,320 crore over Rs 145 crore is 9.10 times. Rs 1,332 crore over Rs 132 crore is 10.09 times. Rs 1,332 crore over Rs 145 crore is 9.19 times. Rs 1,392 crore over Rs 132 crore is 10.55 times. Rs 1,392 crore over Rs 145 crore is 9.60 times.

The last row carries a small discipline that matters more than it looks. Subtracting the rounded 10.55 from the rounded 9.10 gives 1.45. The same subtraction worked on the unrounded values, 10.5455 less 9.1034, gives 1.4420. Rounded, the spread is 1.44 turnsA turn is one whole unit of a multiple. Moving from 9.10 times to 10.10 times is a movement of one turn.. Rounding twice and then subtracting produces a number that ties back to nothing, so a figure that has to reconcile with anything is always worked on unrounded values. The two answers differ by a hundredth of a turn here and nobody is harmed, but the same habit applied to a leverage covenant or a price adjustment produces a figure that no auditor can reproduce, and reproducing a figure is the entire point of writing it down.

Why does a set of single figures read as more precise than it is?

Now back to the sheet somebody slid across the table. Eight rows, one figure each, printed to two decimal places. Every one of those rows had that same choice made for it, by somebody, at some point, and that person did not write down which choice they made. Nobody hid anything. Recording the answer and discarding the working is what everybody does.

A difference between two entries in a set may be a difference of basis rather than a difference of price, and nothing in a row of bare figures lets a reader tell one from the other. Two decimal places look like precision. Two decimal places are precision about the division, and the division was never the uncertain part. The uncertain part was which two numbers went into it, and that has been quietly resolved off screen.

Consider what this does to the comparison actually wanted. The question is whether this purchase was struck on terms similar to others. If entry A was recorded on a headline enterprise value over last year's EBITDA, and entry B was recorded on a maximum enterprise value over a forward condition, then A and B differ on two axes at once, and only one of those axes is price. The reader sees one number and assumes one axis. The set has not lied. The set has been read as though it contained information it never contained.

What has to be recorded beside every multiple?

The practical rule is short enough to memorise. Four notes go beside every multiple, and an entry carrying all four can be compared with another entry carrying all four. Which enterprise value was used. Which EBITDA was used. Which period that EBITDA covers. The date the price was struck.

Each of the four closes a specific hole. Take them one at a time. Naming the enterprise value closes the numerator problem: signing, completion or maximum, and the difference between them on this purchase is Rs 72 crore. Naming the EBITDA closes the denominator problem: earned or conditioned. Naming the period closes a hole every real set meets. One entry may be built on a full financial year and the next on the twelve months to a completion date, and those are not the same window even for the same business. A price agreed eighteen months ago was agreed in different conditions from one agreed last week, and no amount of arithmetic recovers the loss. Naming the date the price was struck closes the hole that time opens.

An entry carrying those four notes can be compared with another entry carrying those four notes, and an entry carrying none of them cannot be compared with anything. One more rule follows, and it is the unpopular half: an entry missing any of the four is left out of the set rather than carried with a caveat. Caveats do not survive. The entry gets copied into somebody else's spreadsheet, the footnote does not travel with it, and six months later the number is being averaged with figures it has no business standing beside.

How do the people around a transaction actually use a set?

Four readers bring four different first questions, and none of them wants the set to settle anything.

Devyani Kulkarni, as chief financial officer of Harivansh Packaging Limited, uses a set as a preparation tool rather than a decision tool. Her board is going to ask whether Rs 1,320 crore looks like a normal price for this kind of business, and she needs to be able to answer that without flinching. Beside each entry she needs the basis noteThe short record kept beside a multiple stating which figures were divided and when, so that somebody else can reproduce it later.. The first question from any sharp director is which EBITDA the comparison used, and an answer of "the published one" ends the discussion badly.

Ashwin Rege and the transaction team use it to find the edges of a negotiation rather than its middle. If a set shows a band, the useful information is what sits at the top of the band and what those purchases had that this one does not, and that question is answered by reading about the businesses, not by staring at the multiples. The set tells them where to look. The set does not tell them what they will find.

A lender to the purchase reads a set for a different purpose again. The test is whether the price being financed is far enough from the ordinary to need explaining. A lender is not trying to judge value. A lender is trying to establish that the borrowing rests on an asset acquired at a price other buyers would recognise. Recognition of that kind is a question about position, and position is the one thing a set genuinely supplies.

And a seller uses a set as an argument. Arguing is not a criticism of the seller, it is the job. A seller who can put a purchase beside three others at higher multiples has changed the shape of the room, and a buyer who cannot say which basis those three were recorded on has walked into it unarmed. The household version is buying a used two wheeler: the seller quotes what three others sold for, and the buyer has no idea whether those three had the same kilometres on them. The person who has recorded the basis of every entry is not being pedantic, they are the only one in the room who can tell whether the comparison being made is a comparison at all.

Was 10.0 times a sensible price to pay?

Whether the price was sensible is a separate judgement. Everything above is checkable. Rs 1,140 crore plus Rs 180 crore is Rs 1,320 crore whoever does the addition, and Rs 1,392 crore over Rs 145 crore is 9.60 times on any calculator in any country. The moment somebody asks whether the price was sensible, they have left the part that can be checked.

Answering that question needs the businesses behind the other entries, and a comparable set carries prices rather than businesses. To say this purchase was cheap against the set would require knowing that the businesses behind those other prices grow the way Sundarban Polymers grows, hold customers the way it holds customers, and need capital the way it needs capital. A row of multiples contains none of that. A row of multiples contains the outputs of other people's judgements, with the judgements removed.

There is a second reason, and it is the more honest one. Whether Harivansh Packaging Limited paid the right amount depends on what that money would otherwise have done and on what the combined business goes on to achieve. Neither of those is in any published figure and neither is knowable now. So the strongest statement available is that the figures reconcile, that six multiples exist, and that the entry has been recorded in a way somebody else can reproduce. A reconciled entry is a smaller claim than a verdict. A reconciled entry will also still be true in five years.