Acquisition Values

Acquisition values can be a useful part of an investor’s valuation toolkit. As Michael Price points out, these are particularly meaningful because they are not theoretical: they represent what an informed, sophisticated buyer is actually willing to pay for a business.

I like to pay close attention to when there is an acquisition to see what price was paid for the business, and I have begun to build a database of past deals within my circle of competence that I can refer to when evaluating a possible investment. Bear in mind that, just like the market in general, acquisitions are subject to irrational exuberance. Also, focus on deals that were done in the last couple years, keeping in mind the macro economic conditions that prevailed when the deal was done.

This morning it was announced that two private equity firms are close to a deal to purchase the clothing retailer J. Crew for $43.50 a share. J. Crew closed yesterday at $37.65 a share so the offer represents a premium of approximately 15%. One common metric used to value these types of deals is ratio of the enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA).

Caution: I think this metric has utility as a comparative metric because it normalizes differences in capital structure and tax rates and is widely used by investment banks and investment firms, but, following Buffett, I think it is deficient in helping to determine the intrinsic value of a business because it does not include the cost of capital expenditures which are essential to maintaining and growing a business.

At the offer price ($43.50), J. Crew has an EV/EBITDA of 7.3.

Based on yesterday’s closing prices, here is the EV/EBITDA ratio for several of J. Crew’s competitors:

Abercrombie & Fitch Co. – 8.1

American Eagle Outfitters Inc. – 6.8

Gap Inc. – 4.2

Urban Outfitters – 11.1

Aerospotale – 4.5

Based on this metric, Gap and Aeropostale look undervalued.

Share

4 thoughts on “Acquisition Values

  1. Andrew Schneck

    Keep in mind that most acquisitions involve a good deal of debt… they are paying prices that don’t make sense for you or I simply because they don’t have to put up much equity. Many an acquisition have failed and I’d be surprised if there was a lot to learn unless you already knew the buyer’s capital allocation record well. I’d pay more attention to hedge fund buying habits than acquisitions being made.

    Aeropostale is undervalued. I’ve done research to stand by this- the only concern is really high cotton prices for the year. I normally don’t allow macro to influence my decision making, but it is a concern of mine considering the prices have doubled. Aero buys their clothing through 5 vendors with production in Asia & Central America and because of this move to lower-cost facilities, the apparel industry has been deflationary for 15+ years. However, many insiders are expecting this to shift soon, so I figure I wouldn’t over-concentrate in ARO b/c there is a real possibility of rising costs. I put about 15% portfolio in at about $2.1 B market value. I think it’s worth about $3.3 B today, and I would consider this a very good business.

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *